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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
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ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2001
Commission file number 0-30218
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TIME WARNER TELECOM INC.
(Exact name of Registrant as specified in its charter)
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Delaware 84-1500624
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
10475 Park Meadows Drive
Littleton, CO 80124
(Address of Principal Executive Offices)
(303) 566-1000
(Registrant's Telephone Number, Including Area Code)
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Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Class A Common Stock, $.01 par value
Indicate by check mark whether the Registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. YES [X] NO [_]
Indicate by check mark if disclosure of delinquent filer pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [_]
As of February 28, 2002, the aggregate market value of the Registrant's
voting stock held by non-affiliates of the Registrant was approximately $276.5
million, based on the closing price of the Company's Class A common stock on
the Nasdaq National Market on February 28, 2002 of $5.70 per share.
The number of shares outstanding of Time Warner Telecom Inc.'s common stock
as of February 28, 2002 was:
Time Warner Telecom Inc. Class A common stock--48,799,191 shares
Time Warner Telecom Inc. Class B common stock--65,936,658 shares
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CAUTION REGARDING FORWARD-LOOKING STATEMENTS
This document contains certain "forward-looking statements," within the
meaning of the Private Securities Litigation Reform Act of 1995, including
statements regarding, among other items, the Company's expected financial
position, business, and financing plans. These forward-looking statements are
based on management's current expectations and are naturally subject to risks,
uncertainties, and changes in circumstances, certain of which are beyond the
Company's control. Actual results may differ materially from those expressed
or implied by such forward-looking statements.
The words "believe," "plan," "target," "expect," "intends," and
"anticipate," and expressions of similar substance identify forward-looking
statements. Although the Company believes that the expectations reflected in
such forward-looking statements are reasonable, it can give no assurance that
those expectations will prove to be correct. Important factors that could
cause actual results to differ materially from the expectations described in
this report are set forth under "Risk Factors" in Item 1 and elsewhere in this
report. Readers are cautioned not to place undue reliance on these forward-
looking statements, which speak only as of their dates. The Company undertakes
no obligation to publicly update or revise any forward-looking statements,
whether as a result of new information, future events, or otherwise.
TELECOMMUNICATIONS DEFINITIONS
In order to assist the reader in understanding certain terms relating to
the telecommunications business that are used in this report, a glossary is
included following Part III.
PART I
Item 1. Business
Overview
Time Warner Telecom Inc. (the "Company") is a leading fiber facilities-
based provider of metropolitan and regional optical broadband networks and
services to business customers. The Company delivers broadband data, dedicated
Internet access, and local and long distance voice services in 44 metropolitan
markets in the United States as of December 31, 2001. The Company's customers
are principally telecommunications-intensive businesses, long distance
carriers, Internet service providers ("ISPs"), incumbent local exchange
carriers ("ILECs"), wireless communications companies, and governmental
entities. During 2001, the Company expanded its local and regional networks
into the western United States through the acquisition out of bankruptcy of
substantially all of the assets of GST Telecommunications, Inc. ("GST"). The
Company also activated networks in five additional markets during 2001. As of
December 31, 2001, the Company's networks covered 16,806 route miles,
contained 758,060 fiber miles, and offered service to 10,685 buildings served
either entirely by the Company's facilities ("on-net") or through the use of
facilities of another carrier to provide a portion of the link ("off-net") in
21 states.
The Company's principal executive offices are located at 10475 Park Meadows
Drive, Littleton, Colorado 80124, and the telephone number is (303) 566-1000.
Time Warner Cable (now a unit of AOL Time Warner Inc.) began the Company's
business in 1993. During the last few years, the Company's business has
changed substantially with an exclusive focus on business customers, including
carriers and governmental entities, and a rapid expansion into switched
services and geographic areas beyond the Time Warner Cable footprint.
In July 1998, the Company was reorganized into a limited liability company,
Time Warner Telecom LLC ("TWT LLC"), and conducted an offering of $400 million
principal amount of 9 3/4% Senior Notes due July 2008. In the transaction,
referred to as the "Reorganization," Time Warner Inc. (now wholly owned by AOL
Time Warner Inc.), MediaOne Group, Inc. (now wholly owned by AT&T Corp.), and
Advance/Newhouse Partnership either directly or through subsidiaries, became
the owners of all of the limited liability company interests in TWT LLC.
In May 1999, in preparation for the Company's initial public offering, TWT
LLC was reconstituted as a Delaware corporation through the conversion of TWT
LLC's limited liability company interests into common stock of the newly
formed corporation, Time Warner Telecom Inc. This transaction is referred to
as the "Reconstitution." Also in May 1999, in conjunction with the
Reconstitution, the Company completed an initial public offering ("IPO") of
20,700,000 shares of Class A common stock at a price of $14 per share.
As a result of the IPO, the Company has two classes of common stock
outstanding, Class A common stock and Class B common stock. Holders of Class A
common stock have one vote per share and holders of Class B common stock have
ten votes per share. Each share of Class B common stock is convertible, at the
option of the holder, into one share of Class A common stock. Currently the
Class B common stock is collectively owned directly or indirectly by AOL Time
Warner Inc., Advance Telecom Holdings Corporation, and Newhouse Telecom
Holdings Corporation (collectively, the "Class B Stockholders").
MediaOne Group, Inc. ("MediaOne"), a former holder of Class B common stock,
completed an underwritten offering on May 1, 2000 of 9,000,000 shares of Class
A common stock of the Company, 8,987,785 of which were converted from shares
of Class B common stock. The Company did not receive any proceeds nor did its
total shares outstanding change as a result of this transaction. On June 15,
2000, MediaOne merged with AT&T Corp. ("AT&T") and the Class B common stock
previously beneficially owned by a MediaOne subsidiary became beneficially
owned by AT&T. In June 2001, AT&T converted its remaining 6,289,872 shares of
Class B common stock into Class A common stock.
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Business Strategy
The Company's primary objective is to be a leading provider of superior
telecommunications services through advanced networks in its service areas to
medium- and large-sized businesses. The key elements of the Company's business
strategy include the following:
Leverage Existing Fiber Optic Networks. The Company has designed and built
local and regional fiber networks to serve geographic locations where
management believes there are large numbers of potential customers. As of
December 31, 2001, the Company operated networks that spanned 16,806 route
miles and contained 758,060 fiber miles. In addition, the Company operates a
fully managed, fiber-based nationwide Internet protocol ("IP") network to
provide the capacity and high quality level of service increasingly demanded
by its customers. That network's capacity was expanded in 2001 and ranges in
throughput capacity from OC-3 to OC-48, depending on the specific route. The
Company's IP backbone includes long haul circuits leased from other carriers.
Management believes that the Company's extensive broadband network capacity
allows it to:
. increase orders substantially from new and existing customers while
realizing higher gross margins than non-fiber facilities-based carriers;
. emphasize its fiber facilities-based services rather than resale of
network capacity of other providers and extend its services both locally
and regionally; and
. provide better customer service because the Company can exert greater
control over its services than its competitors that depend on off-net
facilities.
As of December 31, 2001, the Company completed its previously announced
plan to launch service in five new markets during 2001. The Company plans to
increase penetration in existing markets and does not currently intend to
expand into additional new markets. The Company continues to extend its
network in its present markets in order to reach additional commercial
buildings directly with its fiber facilities. In addition, the Company has
deployed new technologies such as dense wave division multiplexing ("DWDM") to
provide additional bandwidth and higher speed without the need to add
additional fiber capacity.
Expand Service Offerings. The Company provides a broad range of switched
services throughout its service area. The Company utilizes high-capacity
digital end office switches that enable the Company to offer both local and
toll services to its customers. The Company has also installed "softswitches"
that enable the switching of voice calls over an IP and local area network
("LAN") infrastructure in certain markets. The softswitches are capable of
providing digital trunks and Primary Rate Interface ("PRI") services. The
Company expects to be able to provide other voice services over IP during
2002.
Data services are increasingly important to the Company's targeted end user
and carrier customer base. In particular, the Company believes that the demand
for high-speed, high-quality LAN and wide area network connectivity using
Ethernet protocol will continue to grow over the long term. The Company
expects this demand will grow in support of specific applications such as
website hosting, e-commerce, intranet, and Internet access. The Company will
continue to deliver high-speed traditional transport services (e.g., DS-1, DS-
3, and OC-n) through its fiber optic networks, but will also focus on the
delivery of next generation data networking and converged network services,
meaning voice and data applications delivered over a common network
infrastructure. The Company anticipates that the converged network will be
capable of providing applications such as virtual private networking, hosted
web and e-mail services, and new applications such as unified messaging. The
Company believes the key to the evolution of the converged network is delivery
of management services along with network service so that medium and small
business customers in multi-tenant buildings the Company serves can rely on it
to manage the network 24 hours-a-day, 7 days-a-week.
Target Business Customers. The Company operates networks in metropolitan
areas with high concentrations of medium- and large-sized businesses,
including other carriers. These businesses are potentially high-volume users
of the Company's services and are more likely to seek the greater reliability
provided by an advanced network such as the Company's. To drive revenue growth
from these customers, the Company expanded
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its direct sales force. In addition, in order to achieve further economies of
scale and network utilization, the Company is targeting smaller business
customers in buildings the Company already serves where it can offer a package
of network services that may not otherwise be available to those customers. As
a result of weakness in the carrier sector, the Company has sought to broaden
its revenue base by an increased focus on end user (non-carrier) customers and
a focus on established carrier customers.
Interconnect Service Areas. The Company groups the service areas in which
it operates into geographic clusters across the United States. The Company
selectively interconnects certain of its existing service areas within
regional clusters with owned or leased fiber optic facilities. The
interconnection of service areas is expected to increase the Company's revenue
potential and increase margins by addressing customers' regional long
distance, voice, data, and video requirements.
Utilize Strategic Relationships with AOL Time Warner Inc. and its
Affiliates. The Company has benefited from and continues to leverage its
relationships with Time Warner Cable, one of the largest multiple system cable
operators in the U.S., by licensing and sharing the cost of fiber optic
facilities. This licensing arrangement allows the Company to benefit from Time
Warner Cable's access to rights-of-way, easements, poles, ducts, and conduits.
See "Certain Relationships and Related Transactions." By leveraging its
existing relationship with Time Warner Cable, the Company believes that it can
benefit from existing regulatory approvals and licenses, derive economies of
scale in network costs, and extend its existing networks in a rapid,
efficient, and cost-effective manner. Furthermore, management believes that
the strong awareness and positive recognition of the "Time Warner" brand name
contributes to its marketing programs and sales efforts by distinguishing it
from its competitors. In addition, the Company has entered into agreements
with various units of AOL Time Warner Inc., to provide switched, dedicated,
data and Internet services to those units.
Continue Disciplined Expenditure Program. The Company increases operational
efficiencies by pursuing a disciplined approach to capital expenditures. This
capital expenditure program requires that prior to making expenditures on a
project, the project must be evaluated to determine whether it meets stringent
financial criteria such as minimum recurring revenue, cash flow margins, and
rate of return. Until the economy improves, the Company expects that capital
expenditures will generally be limited to building entries, electronics, and
distribution rings based on specific revenue opportunities in existing
markets, as well as upgrades to its back office systems. In addition, the
Company's disciplined spending approach allowed it to adjust operating expense
spending appropriately as revenue growth declined in 2001, thus maintaining
strong margins.
Services
The Company currently provides its customers with a wide range of
telecommunications services, including dedicated transport, local switched,
long distance, data and video transmission services, and high-speed dedicated
Internet access services. The Company's dedicated services, which include
private line and special access services, use high-capacity digital circuits
to carry voice, data, and video transmissions from point-to-point in multiple
configurations. The Company provides advanced video transport services such as
point-to-point, broadcast-quality video to major television networks as well
as to advertising agencies and other customers. Switched voice services
offered by the Company use high-capacity digital switches to route voice
transmissions anywhere on the public switched telephone network. In offering
its dedicated transport and switched services, the Company also provides
private network management and systems integration services for businesses
that require combinations of various dedicated and switched telecommunications
services. Data transmission services provided by the Company allow customers
to create their own internal computer networks and access external computer
networks and the Internet. Internet services provided by the Company include
dedicated Internet access, website and e-mail hosting, and Ethernet and
optical transport services for business customers and local ISPs.
Dedicated Transport Services
The Company currently provides a complete range of dedicated transport
services with transmission speeds from 1.544 megabits per second to 9.953
gigabits per second to its carrier and end user customers. These services
4
can be used for voice, data, image, and video transmission. The Company offers
the following dedicated transport links:
. POP-to-POP Special Access. Telecommunications lines linking the points
of presence ("POPs") of one interexchange carrier ("IXC") or the POPs of
different IXCs in a market, allowing the POPs to exchange transmissions
for transport to their final destinations.
. Interexchange Carrier Special Access. Telecommunications lines between
customers and the local POPs of IXCs.
. Private Line. Telecommunications lines connecting various locations of a
customer's operations, suitable for transmitting voice and data traffic
among customer locations.
. Metropolitan and Regional. Each transport service is available on the
Company's metropolitan fiber networks. Most are also available between
cities on the Company's inter-city, regional networks, now reaching 29
major markets.
. Transport Arrangement Service. Dedicated transport between the Company's
equipment collocated within local exchange carrier ("LEC") central
offices and the IXC POP designated by end user customers. The
arrangement can transport either special access or switched access, and
gives end user customers competitive choice for reaching IXCs.
Each service uses high-capacity digital circuits and can carry voice, data,
and video transmissions with flexible configurations and a variety of circuit
capacities:
. Broadcast video TV-1. Dedicated transport of broadcast television
quality video signals over fiber optic networks.
. SONET Services. Full duplex transmission of digital data on Synchronous
Optical Network ("SONET") standards. The Company's local SONET services
allow multipoint transmission of voice, data, or video over protected
fiber optic networks. Available interfaces include DS-1, DS-3, STS-1,
OC-3, OC-12, OC-48, and OC-192.
. Private Network Transport Services. A premium quality, fully redundant,
and diversely routed SONET service that is dedicated to the private use
of individual customers.
. Wavelength or "Lambda" Services. Extremely high capacity, point-to-point
transmission services using DWDM interfaces. Customers have access to
multiple full-bandwidth channels of 2.5 gigabits per second and 10
gigabits per second.
Switched Services
The Company's switched voice services provide business customers with local
calling capabilities and connections to their IXCs. The Company owns, houses,
manages, and maintains the switches used to provide the services. The
Company's switched services include the following:
. Business Access Line Service. This service provides voice and data
customers quality analog voice grade telephone lines for use at any
time. Business access line service provides customers with flexibility
in network configurations because lines can be added, deleted, and moved
as needed.
. Access Trunks. Access trunks provide communication lines between two
switching systems. These trunks are utilized by private branch exchange
customers, which own and operate a switch on their own premises. Private
branch exchange customers use these trunks to provide access to the
local, regional, and long distance telephone networks. Private branch
exchange customers may use either the Company's telephone numbers or
their ILEC-assigned telephone numbers. Customer access to the Company's
local exchange services is accomplished by a DS-1 digital connection or
DS-0 analog trunks between the customer's private branch exchange port
and the Company's switching centers.
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. Local Toll Service. This service provides customers with a competitive
alternative to ILEC service for intraLATA toll calls. It is a
customized, high-quality local calling plan available to the Company's
local exchange service customers.
. Local Telephone Service. Local telephone service can be tailored to a
customer's particular calling requirements. Local telephone service
includes operator and directory assistance services, custom calling
features such as call waiting and caller ID.
. Long Distance Service. Long distance service provides the capabilities
for a customer to place a voice call from one local calling area to
another, including international calling. The long distance offering is
comprised of a full suite of basic long distance services, including
toll-free 800 number service, calling card, and international calling.
The Company offers long distance services bundled with other Company
services because it believes small- and medium-sized businesses may
prefer to obtain long distance, local, and Internet services from a
single provider instead of working with multiple carriers. The Company
also offers usage-based rates for 1+ and toll-free service as well as
package plans for various committed levels of usage. The target
customers are small- and medium-sized business customers. Generally,
large businesses tend to obtain their long distance services directly
from the major long distance carriers.
. Switched Access Service. The connection between a long distance
carrier's POP and an end user's premises that is provided through the
switching facilities of a LEC is referred to as switched access service.
Switched access service provides IXCs with a switched connection to
their customers for the origination and termination of long distance
telephone calls or provides large end users with dedicated access to
their IXC of choice.
. Other Services. The Company also provides bundled solutions to small- to
medium-sized business users. These solutions provide DS-0 (64 Kbps)
channels to which a customer's voice and Internet services can be
connected for integration to a single DS-1 (1.544 Mbps) transport
facility. Many customers purchase voice (local and long distance) on
separate DS-1 or DS-0 facilities. These customers will often have one
vendor for their local service and a different vendor for their long
distance. Additionally, such customers might also purchase Internet
services from yet another vendor on a variety of DS-0 or DS-1
facilities. Such an arrangement results in having three different
vendors and producing at least three different monthly bills. The
Company's bundled offerings enable customers to purchase a single DS-1
transport facility over which lines, trunks, long distance, and Internet
services can be combined to provide an integrated service offering.
Other services offered by the Company include telephone numbers,
listings, customized calling features, voice messaging, hunting,
blocking services, and two-way, simultaneous voice and data transmission
in digital formats over the same transmission line, which is an
international standard referred to as integrated services digital
network or "ISDN."
Data Transmission Services
The Company offers its customers a broad array of data transmission
services that enable customers to create their own internal computer networks
and access external computer networks and the Internet.
In 2001, the Company extended its current base of transparent LAN services
to include a point-to-point Native Local Area Network ("NLAN") service to
customers. NLAN services allow customers to link multiple locations together
over dedicated lines via the Company's high-speed Ethernet interfaces. This
extended bandwidth capacity allows customers to connect at very high speeds to
the Internet, to the application service provider of choice, or to other
customer locations.
The Company also offers unmanaged point-to-point NLAN service. This service
deploys competitive, low cost, 100 Mbps and 1000 Mbps Ethernet connections.
The service is referred to as "unmanaged" because the fiber between customer
locations is entirely dedicated to that customer and is not monitored by the
Company's
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network operations center. Troubleshooting and maintenance of unmanaged NLAN
circuits requires a service visit by a Company technician.
In 2002, the Company plans to introduce a Managed Fibre Channel Transport
Solution. This service will allow customers to transport data to an off-site
storage facility for back up, mirroring, and disaster recovery purposes.
Internet Services
The Company offers high-speed dedicated Internet access to its business
customers. Dedicated service allows the customer to maintain a permanent,
"always on" connection to the Internet and eliminates the need for slower,
less reliable dial-up modems. The Company upgraded its IP backbone in 2001
from ATM (asynchronous transfer mode) to Packet over SONET ("PoS") technology.
As a result of this upgrade, the network is faster, more efficient and more
reliable. It also offers the Company's customers extremely high levels of
availability and performance.
The Company began to offer dedicated web hosting services in late 2000.
Customers are able to use the dedicated servers owned and operated by the
Company for e-mail, web-site hosting, and file transfer. The Company offers
this service in all of its markets primarily as a value add-on for its data
and Internet services customers.
Limitation on Residential and Content Services
The Company's Restated Certificate of Incorporation prohibits the Company
from (i) engaging in the business of providing, offering, packaging,
marketing, promoting, or branding (alone or jointly with or as an agent for
other parties) any residential services, or (ii) producing or otherwise
providing entertainment, information, or other content services, without the
consent of all the Class B Stockholders. This prohibition expires in May 2004,
or earlier if the Class B Stockholders no longer hold 50% of the total voting
power for the Board of Directors, but a similar restriction in the fiber
license agreements with Time Warner Cable continues until 2028. See "Certain
Relationships and Related Transactions". Although management does not believe
that these restrictions will materially affect the Company's business and
operations in the immediate future, the Company cannot predict the effect of
such restrictions in the rapidly changing telecommunications industry.
Telecommunications Networks and Facilities
Overview. The Company uses advanced technologies and network architectures
to develop a highly reliable infrastructure for delivering high-speed, quality
digital transmissions of voice, data, and video telecommunications services.
The Company's basic transmission platform consists primarily of optical fiber
equipped with high-capacity SONET and DWDM equipment deployed in fully
redundant, self-healing rings. These SONET and DWDM rings give the Company the
capability of routing customer traffic in both directions around the ring,
thereby eliminating loss of service in the event of a fiber cut. The Company
has also deployed a next generation Internet backbone using redundant core
routers to deliver Internet traffic to its customers. The Company's networks
contain softswitches to enable enhanced voice services. The Company's networks
are also designed for remote automated provisioning, allowing the Company to
meet customers' real time service needs. The Company extends SONET rings or
point-to-point links from rings to each customer's premises over its own fiber
optic cable and tail circuits obtained from ILECs. The Company also installs
diverse building entry points where a customer's security needs require such
redundancy. The Company then places necessary customer-dedicated or shared
electronic equipment at a location near or in the customer's premises to
terminate the link.
The Company serves its customers from one or more central offices or hubs
strategically positioned throughout its networks. The central offices house
the transmission, switching, and Internet equipment needed to interconnect
customers with each other, the long distance carriers, and other local
exchange networks. Redundant electronics and power supplies, with automatic
switching to the backup equipment in the event of failure, protects
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against signal deterioration or outages. The Company continuously monitors
system components from its network operations centers and proactively focuses
on avoiding problems rather than merely reacting to trouble.
The Company adds switched, dedicated, and data services to its basic fiber
optic transmission platform by installing sophisticated softswitches and
digital electronics at its central offices and nodes at customer locations.
The Company's advanced digital telephone and IP switches are connected to
multiple ILECs and long distance carrier switches to provide the Company's
customers access to telephones in the local market as well as the public
switched telephone network. The Company also provides routers for its Internet
backbone and LAN multiplexers at its customers' premises and in its central
offices to provide high-speed LAN interconnection services.
The Company's strategy for adding customers is designed to maximize the
speed and impact of its marketing efforts while maintaining attractive rates
of return on capital invested to connect customers directly to its networks.
To serve a new customer initially, the Company may use various transitional
links, such as reselling a portion of an ILEC's network. Once the new
customer's communications volume and product needs are identified, the Company
may build its own fiber optic connection between the customer's premises and
the Company's network to accommodate the customer's needs and maximize the
Company's return on network investment.
Telecommunications Networks. The following chart sets forth information
regarding each of the Company's telecommunications networks as of December 31,
2001:
Switched
Network Services
Commercially Commercially
Metropolitan Service Area Available Available(1)
- ------------------------- ------------ ------------
Albany, New York (2).................................. Jul-95 Sep-99
Albuquerque, New Mexico (3)........................... Jan-01 Jan-01
Atlanta, Georgia...................................... Oct-01 Oct-01
Austin, Texas (2)..................................... Sep-94 Apr-97
Bakersfield, California (3)........................... Jan-01 Jan-01
Binghamton, New York (2).............................. Jan-95 Aug-00
Boise, Idaho (3)...................................... Jan-01 Jan-01
Charlotte, North Carolina (2)......................... Sep-94 Dec-97
Chicago, Illinois..................................... Mar-01 --
Cincinnati, Ohio (2).................................. Jul-95 Nov-97
Columbia, South Carolina (2).......................... Jun-01 Jul-01
Columbus, Ohio (2).................................... Mar-91 Jul-97
Dallas, Texas......................................... Sep-99 Sep-99
Dayton, Ohio (2)...................................... Nov-00 Nov-00
Denver, Colorado...................................... Aug-01 Nov-01
Fayetteville, North Carolina (2)...................... Apr-00 Apr-00
Fresno, California (3)................................ Jan-01 Jan-01
Greensboro, North Carolina (2)........................ Jan-96 Sep-99
Honolulu, Hawaii (2).................................. Jun-94 Jan-98
Houston, Texas (2).................................... Jan-96 Sep-97
Indianapolis, Indiana (2)............................. Sep-87 Dec-97
Jersey City, New Jersey............................... Jul-99 Jul-99
Los Angeles, California (3)(4)........................ Jan-01 Jan-01
Manhattan, New York (2)............................... Feb-96 Feb-98
Memphis, Tennessee (2)................................ May-95 May-97
Milwaukee, Wisconsin (2).............................. Feb-96 Sep-97
Minneapolis, Minnesota (2)............................ Jun-01 Nov-01
Oakland, California (3)(5)............................ Jan-01 Jan-01
Orange County, California............................. Dec-00 Dec-00
Orlando, Florida (2).................................. Jul-95 Jul-97
8
Switched
Network Services
Commercially Commercially
Metropolitan Service Area Available Available(1)
- ------------------------- ------------ ------------
Phoenix, Arizona (3).................................. Jan-01 Jan-01
Portland, Oregon (3).................................. Jan-01 Jan-01
Raleigh, North Carolina (2)........................... Oct-94 Sep-97
Rochester, New York (2)............................... Dec-94 Feb-95
Sacramento, California (3)............................ Jan-01 --
San Antonio, Texas (2)................................ May-93 Nov-97
San Diego, California (2)............................. Jun-95 Jul-97
San Francisco, California (3)......................... Jan-01 Jan-01
San Luis Obispo, California (3)....................... Jan-01 Jan-01
Santa Barbara, California (3)......................... Jan-01 Jan-01
Seattle, Washington (3)............................... Jan-01 Jan-01
Spokane, Washington (3)............................... Jan-01 Jan-01
Tampa, Florida (2).................................... Dec-97 Jan-98
Tucson, Arizona (3)................................... Jan-01 Jan-01
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(1) Date of "Switched Services Commercially Available" is the first date on
which switched services were provided to a customer for markets not
acquired from GST.
(2) Metropolitan statistical areas in which the Company obtains or expects to
obtain fiber capacity through licensing agreements with Time Warner Cable.
See "Certain Relationships and Related Transactions."
(3) The "available" date represents the date the assets were acquired from
GST.
(4) Includes Los Angeles, Riverside, and Ventura.
(5) Includes Oakland and Stockton metropolitan statistical areas.
Western Regional Network. As part of the GST asset acquisition, the Company
acquired a regional fiber optic backbone network, extending from Seattle to
San Diego that was substantially completed during 2001. The capacity of the
network varies along the route, ranging from 12 to 144 fibers and six to eight
two-inch conduits. This regional network interconnects many of the Company's
service areas in its western region and is used to provide regional long
distance, voice, Internet, data, and video transport services. The Company may
sell fiber and conduit routes not needed for its operations or may exchange
such routes for other fiber and conduit routes. As part of the GST
transaction, the Company assumed certain agreements to provide long-term
rights to dark fiber and conduit to third parties. Dark fiber consists of
fiber strands contained within a fiber optic cable that are not connected to
electronic equipment. A lease of dark fiber rights typically has a term that
approximates the economic life of a fiber optic strand (generally 20 to 30
years). Purchasers and lessees of dark fiber rights usually install their own
electrical and optical transmission equipment. A purchaser of conduit rights
pulls its own fiber through the conduit, which may be either a spare conduit
or one that already contains the Company's fiber. In general, payment for dark
fiber and conduit rights is due at the time of delivery and acceptance of the
fiber or conduit. A substantial portion of the routes subject to these
agreements were completed in 2001 and the third party rights the Company
agreed to grant under these agreements were granted and paid for in 2001. The
Company expects to complete the grant of rights to third parties on the
Ontario to San Diego, California route and to receive the corresponding
payments during the first quarter of 2002.
Network Monitoring and Management. The Company provides a single point of
contact for its customers and consolidates its systems support, expertise, and
technical training for the telephony network at its network operations center
in Greenwood Village, Colorado. With approximately 1,260 technicians and
customer service representatives dedicated to providing superior customer
service, the Company is able to quickly correct, and often anticipate,
problems that may arise in its networks. The Company provides 24 hours-a-day,
7 days-a-week surveillance and monitoring of networks to achieve a high level
of network reliability and performance. Network analysts monitor real-time
alarm, status, and performance information for network circuits, which allows
them to react swiftly to repair network trouble. In order to increase
operating efficiencies and reduce expenses, in late
9
2001 the Company began the consolidation of the network operations center in
Vancouver, Washington acquired through the GST asset acquisition into its
Greenwood Village network operations center. The Company expects the
consolidation to be complete by the end of the first quarter of 2002.
The Company also maintains an Internet network operations center in
Milwaukee, Wisconsin that handles all provisioning, call center, and
surveillance functions for the Company's IP backbone and services, including
Internet access and web hosting, provided over the Company's IP backbone.
Infrastructure Migration. The Company continually evaluates new
technologies and suppliers in order to achieve a balance between utilizing
best of breed technologies and suppliers, and purchasing equipment at the best
available price. IP capabilities are proliferating throughout the network as
is evidenced by the rapid development and deployment of packet telephony
systems (e.g., media gateways and softswitches). In order to prepare to
deliver the next generation voice and data services, the Company is using
softswitch, optical, and data/Internet technologies to augment legacy circuit
switched telephone systems and is deploying these technologies in certain
markets to complement circuit switched systems. The Company plans to offer IP
Centrex, packet telephony, metropolitan LAN, storage, and wavelength services
over this platform in 2002. As an extension of the Signaling System 7 ("SS7")
network that the Company acquired in connection with the GST asset
acquisition, in 2001 the Company launched an initiative to extend the acquired
SS7 network to many of its existing networks. The migration to the Company's
internal SS7 network is expected to be complete during 2002 and is expected to
decrease the Company's dependence on other providers.
Information Systems Infrastructure. The Company uses a centrally deployed
series of client server platforms and relational database servers to provide
cost effective computing support for its business functions. These services
and products enable employees to support customers directly, manage the
telephony infrastructure, and report and manage trouble resolution. The
computing infrastructure strategy enables the Company to mix and match
computing platforms to meet its specific business needs including telephony
ordering, provisioning, inventory, engineering, installation, billing,
decision support, and customer care business functions. The strategy of buying
"off the shelf" products and integrating them into the Company's existing
information systems infrastructure versus utilizing several stand-alone
applications supports a more responsive and flexible environment. The
Company's information systems provide real time support of network operations
and deliver data at the network, regional and corporate level, sorted by
customer and vendor. The systems selected or built utilize open system
standards and architectures, allowing interoperability with third parties'
systems. The Company's information technology teams have developed
competencies in application integration using the latest in enterprise
application products and strategies. The Company has implemented an enterprise
resource system, which provides improved real-time management information for
the Company's financial, procurement, and human resource functions.
Network Development and Application Laboratory. The Company's network
development and application laboratory is a comprehensive telecommunications
technology, applications, and services development laboratory, equipped with
advanced systems and equipment, including those used by the Company in the
operation of its local digital networks. The center is designed to provide a
self-contained testing and integration environment, fully compatible with the
Company's digital networks, for the purposes of:
. verifying the technical and operational integrity of new equipment prior
to installation in the networks;
. developing new services and applications;
. providing a realistic training environment for technicians, engineers,
and others; and
. providing a network simulation environment to assist in fault isolation
and recovery.
Technologies currently under evaluation in the laboratory include DWDM
equipment from new vendors, optical switches, next generation Multi Service
Platform, IP telephony, including components used to service next generation
softswitches, media gateway technologies, application servers, and data and
Internet equipment including edge routers and metropolitan Ethernet switches.
10
Billing Systems. The Company contracts with outside vendors for customer
billing. The Company has licensed a system for transport and switched services
billing that it operates on its own equipment and has a service bureau
arrangement with another vendor for carrier and interconnection billing. In
2001, the Company completed the migration of its billing of acquired accounts
from the platforms inherited from the acquisition of GST assets to the billing
platform that the Company uses for its other markets.
Customers and Sales and Marketing
The Company's customers are principally telecommunications-intensive
medium- and large-sized business end users including financial services,
health care, media and technology companies, long distance carriers, ISPs,
wireless communications companies, ILECs, and various governmental entities.
The Company has substantial business relationships with a few large
customers. For the year ended December 31, 2001, the Company's top ten
customers accounted for approximately 47% of its total revenue. Excluding the
impact of the recognition of $37.0 million in non-recurring reciprocal
compensation revenue, the Company's top ten customers accounted for 44% of
revenue in 2001. The Company's largest customer for the twelve months ended
December 31, 2001, WorldCom Inc. and its affiliates, accounted for 12% of the
Company's total revenue. However, a portion of that revenue results from
traffic that is directed to the Company by customers that have selected
WorldCom Inc. as its long distance carrier. No other customer, including
customers who direct their business through long distance carriers, accounted
for 10% or more of the Company's revenue in 2001. In 2001, the three companies
that individually represented more than 5% of total 2001 revenue, excluding
the impact of the non-recurring reciprocal compensation revenue described
above, were WorldCom Inc., AT&T, and Qwest Communications Inc.
The Company maintains a direct sales effort in each of its service areas
along with regional and national sales support. The number of sales account
executives totaled 288 at December 31, 2001. Compensation for the Company's
sales representatives is based primarily on commissions linked to revenue from
services installed. The Company provides enhanced commissions to its sales
force for executing service contracts with terms of two years or greater and
for services entirely on the Company's network. Currently, more than half of
the Company's revenue from services subject to service agreements is provided
under agreements with an initial duration of three years or greater. In
addition, the Company markets it services through advertisements, trade
journals, media relations, direct mail, and participation in trade
conferences.
The Company also targets long distance carriers, ISPs, ILECs, large
strategic business accounts, and wireless telephone companies through its
national sales organization. The Company has master services agreements with a
significant number of the long distance carriers, including AT&T, WorldCom
Inc., Sprint Corporation, and Qwest Communications Inc. By providing long
distance carriers with a local connection to their customers, the Company
enables them to avoid complete dependence on the ILECs for access to customers
and to obtain a high-quality and reliable local connection. The Company
provides a variety of transport services and arrangements that allow long
distance carriers to connect their own switches in both local areas, or intra-
city, and wide areas, or inter-city. Additionally, long distance carriers may
purchase the Company's transport services that allow them to connect their
switch to an ILEC switch and to end user locations directly. The Company's
networks allow it to offer high volume business customers and long distance
carriers uniformity of services, pricing, quality standards, and customer
service.
In 2001, the demand from carrier customers fell and the Company experienced
significant service disconnections as a result of bankruptcies, customers
contracting their operations, and customers optimizing their existing networks
in response to the economic downturn. As a result, the Company increased its
focus on established carrier customers and on end user customers to replace
the revenue lost to disconnections.
The Company's marketing emphasizes its:
. reliable, facilities-based networks;
11
. flexibly-priced, bundled services;
. responsive customer service orientation; and
. integrated operations, customer support, network monitoring, and
management systems.
The Company's centrally managed customer support operations are designed to
facilitate the processing of orders for changes and upgrades in customer
services. To reduce the risk in bringing new and untested telecommunications
services to a dynamically changing market, the Company introduces its services
once market demand develops, and offers them in diversified, competitively-
priced bundles in order to increase usage among its existing customers and
attract new customers. The services offered by the Company are typically
priced at a discount to the ILECs' prices.
Customer Service
With approximately 1,260 technicians and customer service representatives
at December 31, 2001, the Company provides its customers with continuous
support and superior service. To serve its customers, account representatives
are assigned to the Company's customers to act as effective liaisons with the
Company. Technicians and other support personnel are available in each of the
Company's service areas to react to any network failures or problems. In
addition, the network operations center provides 24 hours-a-day, 7 days-a-week
surveillance and monitoring of networks to maintain the Company's network
reliability and performance. See "Telecommunications Networks and Facilities--
Network Monitoring and Management."
Competition
The Company believes that the principal competitive factors affecting its
business are and will continue to be:
. pricing;
. competition for skilled, experienced personnel;
. regulatory decisions and policies that impact competition;
. ability to introduce new services; and
. the availability of proven support systems for the Company's back office
systems, including provisioning and billing.
The Company believes that it competes favorably with other companies in the
industry or is generally impacted favorably with respect to each of these
factors. The technologies and systems that provide back office support for the
competitive local exchange carrier ("CLEC") industry are nascent and may not
keep pace with the growth of order volume, integration with other systems, and
production of required information for systems managers. Although the
Company's ability to attract qualified personnel improved in 2001 as a result
of contraction of the CLEC industry and the economy in general, personnel with
certain types of technical expertise are still in demand and the Company must
compete with other employers by maintaining competitive compensation and
benefits packages, in addition to an attractive work environment. Regulatory
environments at both the state and federal level differ widely and have
considerable influence on the Company's market and economic opportunities and
resulting investment decisions. The Company believes it must continually
monitor regulatory developments and remain active in its participation in
regulatory issues. Some regulatory decisions have or may in the future have
negative impacts on the Company's revenue or expenses, and may favor certain
classes of competitors over the Company. See "Government Regulation."
Services substantially similar to those offered by the Company are also
offered by the ILECs, Verizon Corporation, BellSouth Corporation, Qwest
Communications Inc., and SBC Communications, Inc. The Company believes that
many ILECs may have competitive advantages over the Company such as their
long-standing
12
relationships with customers, greater technical and financial resources, and
the potential to subsidize services of the type offered by the Company from
service revenue in unrelated businesses. However, the Company believes that
its customers are increasingly interested in alternate providers for
redundancy of networks and enhanced disaster recovery. In light of the
bankruptcies in the CLEC sector, some customers are seeking financially stable
providers to a greater extent than in prior years. In most of the metropolitan
areas in which the Company currently operates, at least one, and sometimes
several other CLECs offer substantially similar services at substantially
similar prices to those of the Company.
With several facilities-based carriers providing the same service in a
given market, price competition is likely and can be severe. As a result, the
Company has experienced price competition that is expected to continue. In
addition, the Company believes that weakness in the CLEC sector has led to
below-cost pricing as certain competitors seek to meet revenue targets without
regard to profit margin. During 2001 and continuing into the first quarter of
2002, due to business failures and contractions, the overall number of
competitors declined, and competitors slowed or stopped their build-out plans.
A number of the Company's CLEC competitors have been undergoing restructuring
either in the context of Chapter 11 bankruptcy proceedings or as a result of
serious liquidity problems. Some of these competitors could emerge from these
restructuring transactions with little or no indebtedness, which could lead to
further downward pricing pressure. In each of its service areas, additional
competitors could build facilities. If additional competitors build facilities
in the Company's service areas, this price competition may increase
significantly.
The Company also faces competition from other CLECs, cable television
companies, electric utilities, long distance carriers, wireless telephone
system operators, and private networks built by large end users that
presently, and may in the future, offer services similar to those offered by
the Company.
The Telecommunications Act of 1996 (the "1996 Act") allows the regional
Bell operating companies ("RBOCs") and others, such as electric utilities, to
enter the long distance market. Certain of the RBOCs have begun providing out-
of-region long distance services. When a RBOC obtains authority to provide in-
region interLATA services, it will be able to offer customers both local and
long distance telephone services. Given the market power the RBOCs currently
possess in the local exchange market, the ability to provide both local and
long distance services is expected to make the RBOCs very strong competitors.
To date, two Bell operating companies--Verizon Corporation in New York,
Massachusetts, Rhode Island, Pennsylvania, and Connecticut and Southwestern
Bell Telephone Company in Texas, Kansas, Oklahoma, Arkansas and Missouri--have
been granted authority under Section 271 to provide in-region interLATA
service. Verizon Corporation has also applied to the Federal Communications
Commission ("FCC") for Section 271 authority in New Jersey. It is expected
that the RBOCs will submit additional applications for Section 271 authority
to the FCC in the future.
Additional competition may arise from long haul and calling card service
providers that are attempting to enter the IP telephony market. The Company
cannot predict whether those companies will be successful or whether they will
provide significant competition for the Company's services. At this time, the
FCC has not yet determined whether to subject IP telephony to the same
regulatory requirements applicable to traditional telecommunications services,
including, for example, the obligation to support universal service and the
requirement to pay access charges to LECs.
The Company believes that certain IXCs are pursuing alternatives to their
current practices with regard to obtaining local telecommunications services,
including acquisition or construction of their own facilities. In addition,
IXCs may be able to provide local service by reselling the facilities or
services of an ILEC or the services of another CLEC, which may be more cost
effective for an IXC than using the Company's services.
To the extent the Company interconnects with and uses ILEC networks to
service its customers, the Company depends on the technology and capabilities
of the ILECs to meet certain telecommunications needs of the Company's
customers and to maintain its service standards. The Company also uses ILEC
special access services to reach certain buildings that are not served by the
Company's network. Although the 1996 Act imposes interconnection obligations
on ILECs, the regulation of ILEC performance standards and the imposition of
non-
13
performance remedies is still developing and there is no assurance that the
Company will be able to obtain all of the ILEC services it needs on a timely
basis or that the quality of service it receives will be acceptable. In the
event that the Company experiences difficulties in obtaining high-quality,
reliable, and reasonably priced service from the ILECs, the attractiveness of
the Company's services to its customers could be impaired.
Government Regulation
Historically, interstate and foreign communication services were subject to
the regulatory jurisdiction of the FCC, and intrastate and local
telecommunications services were subject to regulation by state public service
commissions. With enactment of the 1996 Act, competition in all
telecommunications market segments, including local, toll, and long distance,
became matters of national policy. The Company believes that the national
policy fostered by the 1996 Act has contributed to significant market
opportunities for the Company. As federal and state regulatory commissions
have largely implemented the provisions of the 1996 Act, the Company believes
that future regulation will focus largely on enforcement of carrier-to-carrier
requirements under the law and on consumer protection measures.
Telecommunications Act of 1996. The 1996 Act is intended to increase
competition in local telecommunications services by requiring ILECs to
interconnect their networks with CLECs. The 1996 Act imposes a number of
access and interconnection requirements on all LECs, including CLECs, with
additional requirements imposed on ILECs. Under the 1996 Act, ILECs are
required to attempt to negotiate with CLECs wanting to interconnect with their
networks. The Company has successfully negotiated interconnection agreements
with the ILECs in each of the markets in which it offers switched services and
has negotiated, or is negotiating, secondary interconnection arrangements with
carriers whose territories are adjacent to the Company's for intrastate
intraLATA toll traffic and extended area services. To the extent agreements
have expired, the Company has either renegotiated or is in the process of
negotiating new contracts. Typically, expired agreements allow the Company to
continue to exchange traffic with the other carrier pending execution of a new
agreement. Currently, a few ILECs are seeking renegotiation of certain terms
and conditions, including reciprocal compensation for ISP-bound traffic. The
Company cannot predict the outcome of such negotiations, especially in light
of pending legal and regulatory actions pertaining to reciprocal compensation,
as described below.
In August 1996, the FCC promulgated rules to govern interconnection,
resale, unbundled network elements, and the pricing of those facilities and
services, as well as rules to govern, among other things, the dialing parity
requirements of the 1996 Act. Although certain ILECs and states challenged the
authority of the FCC to issue these rules, on review, the Supreme Court upheld
most of the FCC's rules and confirmed the FCC's authority to issue national
pricing rules. The Supreme Court did not, however, address the lawfulness of
the specific pricing rules established by the FCC. In July 2000, this issue
was addressed when the 8th Circuit Court of Appeals found the Total Element
Long Run Incremental Cost ("TELRIC") standard to be unlawful and vacated
certain aspects of the rules. The pricing issue is now pending before the
Supreme Court. Elimination of the TELRIC pricing standard could increase costs
to the Company of interconnection and related services from ILECs.
Reciprocal compensation revenue is an element of switched services revenue
which represents compensation from LECs for local exchange traffic terminated
on the Company's facilities originated by other LECs. Historically, a portion
of the reciprocal compensation revenue payable to the Company, like other
CLECs, has resulted from the termination of calls to the Company's ISP
customers. As dial-up Internet traffic has grown, ILECs have challenged the
requirement to pay reciprocal compensation for ISP-bound traffic under various
legal theories. In June 2001, the FCC reaffirmed its jurisdiction over dial-up
Internet-bound traffic, and adopted an interim carrier-to-carrier cost
recovery scheme for such traffic. The new regulatory scheme phases in
reductions on the maximum compensation rate for dial-up Internet-bound traffic
over a three-year period. The FCC initiated a rulemaking to consider whether
it should replace all existing intercarrier compensation schemes with some
form of "bill and keep". "Bill and keep" means that neither carrier receives
compensation for Internet-bound traffic. The FCC has completed an initial
comment cycle, but there has been no further activity on this proceeding to
date. The interim carrier-to-carrier cost recovery rule will have a negative
impact on the Company's revenue
14
stream. The new regulatory construct also imposes bill and keep payment
arrangements for Internet-bound traffic as carriers enter new markets. As a
result of the FCC's order, state commissions lack authority over Internet-
bound traffic compensation issues, except that state commission decisions
regarding this traffic for prior periods were not affected by the order. The
Company and several other CLECs filed legal challenges to the FCC's order in
federal court. There is no assurance, however, that any legal challenge will
be successful or that a successful challenge will change the trend toward
reduced reciprocal compensation. In some cases the Company's right to receive
reciprocal compensation for traffic terminated to its ISP customers was
contractually dependent on the outcome of regulatory proceedings addressing
reciprocal compensation for ISP traffic. The impact of the FCC's 2001 ruling
on the payment of reciprocal compensation under some of those agreements is
still in dispute with certain ILECs. The rate reductions resulting from the
FCC order and exclusion of ISP-bound traffic from reciprocal compensation
requirements in new markets will reduce the revenue received by the Company
for terminating traffic originated by ILECs. The adoption of a bill and keep
regime for all existing intercarrier compensation schemes would further reduce
the Company's revenue, and to a much lesser extent, its expenses.
Federal Regulation. Switched access is the connection between a long
distance carrier's point of presence and an end user's premises provided
through the switching facilities of a LEC. Historically, the FCC has regulated
the access rates imposed by the ILECs while the CLEC access rates have been
less regulated. In May 2000, the FCC ordered a substantial reduction in ILEC
per-minute access charges and an increase in the flat monthly charge paid by
local residential service subscribers for access to interstate long distance
service. The FCC also released an order effective in June 2001 that subjects
CLECs' interstate switched access charges to regulation. Effective with that
order, the Company's rates were reduced and will continue to decline over a
three-year period to parity with the ILEC rates competing in each area. In
addition, when a CLEC enters a new market its access charges may be no higher
than the ILEC's. This order does not affect rates subject to contracts that
the Company has entered into with certain long distance carriers. The Company
and several other CLECs have filed petitions with the FCC for reconsideration
of the provisions of the order relating to new markets, and other carriers
have challenged the order in federal court. There is no assurance that any
legal challenge will be successful or that a successful challenge will change
the trend toward lower access charges. The ILEC access reform decision, as
well as the CLEC access charge regulation have resulted in reductions in the
per-minute rates the Company receives for switched access service in 2001 and
will likely result in further reductions. There is no assurance that the
Company will be able to compensate for reductions in switched access revenue
resulting from the FCC order with revenue from other sources.
In addition, federal legislation entitled "Internet Freedom and Broadband
Deployment Act of 2001" has passed the U.S. House of Representatives and is
pending before the Senate. This legislation, commonly referred to as HR 1542,
or the Tauzin-Dingell Bill, is designed to prohibit the FCC and each state
from regulating high-speed data services. The Company believes that this
legislation harms telecommunications competition by removing existing
regulation that protects consumers and carriers from monopoly abuses. If
passed, the Company believes HR 1542 could have an adverse impact on the
Company's strategy. The Company cannot predict whether the legislation will
become law in 2002 or ever.
In a February 1999 order, the FCC allowed for increases to commingled cable
and telephony pole attachment rates beginning in February 2001. While there
was no significant impact to the Company in 2001, this order could result in
future increases to the Company's costs associated with pole attachments.
State Regulation. The Company has obtained all state government authority
needed to conduct its business as currently contemplated. Most state public
service commissions require carriers that wish to provide local and other
jurisdictionally intrastate common carrier services to be authorized to
provide such services. The Company's operating subsidiaries and affiliates are
authorized as common carriers in 24 states. These certifications cover the
provision of switched services including local basic exchange service, point-
to-point private line, competitive access services, and long distance
services.
Local Government Authorizations. The Company may be required to obtain from
municipal authorities street opening and construction permits and other
rights-of-way to install and expand its networks in certain
15
cities. In some cities, the Company's affiliates or subcontractors already
possess the requisite authorizations to construct or expand the Company's
networks. Any increase in the difficulty or cost of obtaining these
authorizations and permits could adversely affect the Company, particularly
where it must compete with companies that already have the necessary permits.
In some of the metropolitan areas where the Company provides network
services, the Company pays right-of-way or franchise fees based on a percent
of gross revenue or other metrics such as access lines. However,
municipalities that do not currently impose fees may seek to impose fees in
the future, and following the expiration of existing franchises, fees may be
increased. Under the 1996 Act, municipalities are required to impose such fees
on a competitively neutral and nondiscriminatory basis. However,
municipalities that currently favor the ILECs may or may not conform their
practices in a timely manner or without legal challenges by the Company or
another competitive access provider or CLEC. Moreover, ILECs with whom the
Company competes may be excluded from such local franchise fee requirements by
previously-enacted legislation allowing them to utilize rights-of-way
throughout their states without being required to pay franchise fees to local
governments.
If any of the Company's existing franchise or license agreements for a
particular metropolitan area were terminated prior to its expiration date and
the Company were forced to remove its fiber optic cables from the streets or
abandon its network in place, even with compensation, such termination could
have a material adverse effect on the Company's operation in that metropolitan
area and could have a material adverse effect on the Company.
The Company is party to various regulatory and administrative proceedings;
however, subject to the discussion above, the Company does not believe that
any such proceedings will have a material adverse effect on its business.
Employees
As of December 31, 2001, the Company had 2,661 employees. The Company is
eliminating approximately 200 positions primarily in its Vancouver, Washington
operations in a consolidation of its network operations centers that is
expected to be completed by the end of the first quarter of 2002. The Company
believes that its relations with its employees are good. By succession to
certain operations of Time Warner Cable, the Company's operation in New York
City is a party to a collective bargaining agreement. In connection with the
construction and maintenance of its networks and the conduct of its other
business operations, the Company uses third party contractors, some of whose
employees may be represented by unions or collective bargaining agreements.
The Company believes that its success will depend in part on its ability to
attract and retain highly qualified employees and maintain good working
relations with its current employees.
Risk Factors
Some of our customer agreements may not continue and customers may continue
to disconnect services.
Some of our customer agreements are subject to termination on short notice
and do not require the customer to maintain its agreements at current levels.
We cannot assure that such customers will continue to purchase the same
services or level of services. In fact, we have experienced significant
service disconnections in 2001 due to customer bankruptcies, customers
contracting their operations and customers optimizing their existing networks
in response to the economic downturn. In addition, we believe that certain
IXCs are pursuing alternatives to their current practices with regard to
obtaining local telecommunications services, including acquisition or
construction of their own facilities. Although the Company was successful in
replacing revenue lost in 2001 to disconnections or other customer
difficulties, there is no assurance that the Company will continue to be able
to do so.
During 2001, a number of our customers filed bankruptcy proceedings. In
connection with those proceedings, the customers may choose to assume or
reject their contracts with us. If they choose to reject those
16
contracts, our only recourse is an unsecured claim for rejection damages that
is likely to result in little or no compensation to us for the lost revenue.
As of December 31, 2001, less than 4% of the Company's monthly revenue was
represented by customers that had filed bankruptcy proceedings and that could
reject or otherwise terminate their agreements with the Company. Since
December 31, 2001, additional customers filed bankruptcy proceedings bringing
the total percentage of monthly revenue from customers in bankruptcy to
approximately 5%. Customer bankruptcies are likely to continue until the
economy improves, and there is no assurance that the Company will not continue
to lose significant recurring revenue due to customer bankruptcies.
Our acquisition of the GST assets increased our leverage and poses other
risks.
Our acquisition of the GST assets is considerably larger than the
transactions we have completed in the past. Although we have completed the
first phase of the integration of these assets into our business--integrating
the sales, marketing, and operations--the integration of our back office
systems is not expected to be completed until the end of 2002. In 2001, our
gross margins from the acquired operations were worse than the margins for our
core business (meaning the historic regions and operations of the Company,
including the five new markets activated in 2001).
Although the Company believes it is in a position in 2002 to improve those
margins, potential risks include the inability of the Company to grow revenue
from the acquired assets, the inability of the Company to achieve operating
efficiencies, the possible difficulty of managing our growth and information
systems, and the possibility that the liabilities we assumed to complete
performance under GST contracts may prove to be greater than anticipated.
We may have difficulty achieving the benefits intended from the acquisition
of the GST assets.
We purchased substantially all of the assets of GST with the expectation
that the asset purchase would result in certain benefits, including expansion
of the markets we serve and increasing our operational efficiencies. Achieving
the benefits of the asset purchase will depend upon the successful integration
of the acquired businesses into our existing operations, much of which has
already occurred, and our ability to generate substantial additional revenue
from those assets. We cannot assure that we will be successful in achieving
the anticipated benefits of the acquired GST assets. The risks associated with
the acquisition include but are not limited to:
. the diversion of our management's attention, as integrating the GST
operations and assets has required and will continue to require a
substantial amount of management time;
. difficulties associated in assimilating GST's information systems;
. the inability to generate substantial revenue from the regional network
assets, which will require significant expense to maintain.
The Company cannot assure that it will be able to successfully overcome the
risks associated with integrating the assets it acquired from GST and
generating sufficient additional revenue at attractive margins.
We will require substantial capital to expand our operations.
The development and expansion of our networks requires substantial capital
investment. If this capital is not available when needed, our business will be
adversely affected. The Company expects its 2002 capital expenditures to be
less than the 2001 total of $425 million. We expect our principal capital
requirements for 2002 to be for additional building entries and distribution
rings needed to reach additional customers, and upgrades to our management
information and back office systems. We also expect to have substantial
capital expenditures in subsequent periods.
In December 2000, we executed agreements replacing our $475 million senior
secured credit facility with a $1 billion amended and restated senior secured
credit facility, and in January 2001 completed an offering of $400
17
million principal amount of 10 1/8% Senior Notes. The acquisition of the GST
assets was initially financed in January 2001 with borrowings under an
unsecured bridge loan facility that was repaid in full with $532 million in
net proceeds from the Company's offering of Class A common stock in January
2001 and a portion of the net proceeds from the sale of the 10 1/8% Senior
Notes. As of December 31, 2001, we have drawn $250 million of the $1 billion
senior secured credit facility. We may be required to seek additional
financing if:
. our business plans and cost estimates prove to be inaccurate;
. we decide to accelerate the expansion of our business and existing
networks;
. we consummate further acquisitions or joint ventures that require
capital; or
. we are not able to generate sufficient cash flow from operations.
If we were to seek additional financing, the terms offered may place
significant limits on our financial and operating flexibility, or may not be
acceptable to us. The failure to raise sufficient funds if needed and on
reasonable terms may require us to modify or significantly curtail our
business plan. This could have a material adverse impact on our growth,
ability to compete, and ability to service our existing debt.
The Company's senior secured credit facility and the indentures for the 9
3/4% Senior Notes and the 10 1/8% Senior Notes contain restrictive covenants
that may limit our flexibility.
The senior secured credit facility and indentures limit, and in some
circumstances prohibit, our ability to:
. incur additional debt;
. pay dividends;
. make investments or other restricted payments;
. engage in transactions with stockholders and affiliates;
. create liens;
. sell assets;
. issue or sell capital stock of subsidiaries; and
. engage in mergers and acquisitions.
These covenants may limit our financial and operating flexibility. In
addition, if we do not comply with these covenants and financial covenants in
the senior secured credit facility that require the Company to maintain
certain minimum financial ratios, the lenders under the senior secured credit
facility and the holders of the 9 3/4% and 10 1/8% Senior Notes may accelerate
repayment of our debt. The financial ratios include interest coverage,
leverage, senior leverage, and debt service coverage ratios. See Item 7.
Management's Discussion and Analysis of Financial Conditions and Results of
Operations--Liquidity and Capital Resources for a description of these ratios.
In addition, the lenders under the senior secured credit facility could refuse
to lend additional funds if we are not in compliance. The Company could be in
non-compliance with financial covenants in the future due to factors beyond
its control such as losses of revenue or reduction in margins or impairment of
its assets.
Our substantial indebtedness, and servicing our indebtedness, may impair our
financial and operating flexibility.
As of December 31, 2001, we had approximately $1.1 billion of consolidated
total long-term debt. This substantial indebtedness may have an adverse impact
on us. For example:
. our ability to obtain additional financing may be limited;
. a substantial portion of our cash flow will be dedicated to pay interest
and principal on our debt;
18
. our ability to satisfy our debt obligations may be diminished;
. we may be more vulnerable to economic downturns; and
. our ability to withstand competitive pressure may decrease.
The Company may be required to record an impairment charge in the future.
Under generally accepted accounting principles, the Company is required to
review the carrying amounts of its assets to determine whether current events
or circumstances warrant adjustments to those amounts. These determinations
are based in part on management's judgments regarding the cash flow potential
of various assets, and involve projections that are inherently subject to
change based on future events. If management concludes in the future that the
cash flow potential of any of its assets is significantly less than it
believed at the time of purchase, and that conclusion is based on a long-term
rather than short-term trend, the Company may need to record an impairment
charge. Although the Company does not believe that any of its assets are
currently impaired, that judgment could change based on changed circumstances.
An impairment charge would have a negative impact on the Company's earnings.
To service our indebtedness, we will require a significant amount of cash,
and our ability to generate cash depends on many factors beyond our control.
Our ability to make payments on our indebtedness and to fund planned
capital expenditures will depend on our ability to generate cash in the
future.
Our historical financial results have been, and our future financial
results might be, subject to substantial fluctuations. We cannot assure that
our business will generate sufficient cash flow from operations, that
currently anticipated cost savings and operating improvements will be realized
on schedule, or that future borrowings will be available to us in an amount
sufficient to enable us to pay our indebtedness or fund our other liquidity
needs. These uncertainties are exacerbated by the current economic downturn.
If we are unable to pay our debts, we will be required to pursue one or more
alternative strategies, such as selling assets, refinancing or restructuring
our indebtedness, or selling equity capital. However, we cannot assure that
any alternative strategies will be feasible at the time due to market
conditions or other factors, or that such strategies would prove adequate.
Also, certain alternative strategies will require prior consent of our debt
holders.
Our business may be adversely affected if we do not successfully manage the
expansion of our new markets and services.
We plan to offer new communications services, expand service in our
existing markets, and interconnect our existing markets. If we are not
successful in implementing these changes on-time and on-budget, our results of
operations will likely be adversely affected.
Our ability to manage this expansion depends on many factors, including the
ability to:
. attract new customers and sell new services to existing customers;
. design, acquire, and install transmission and switching facilities;
. employ new technologies;
. obtain any required governmental permits and rights-of-way;
. implement interconnection with ILECs;
. train and manage our employee base;
. enhance our financial, operating, and information systems to effectively
manage our growth; and
. accurately predict and manage the cost and timing of our capital
expenditure programs.
19
Even if we are successful in completing the infrastructure to support our
expanded business, that business may not be profitable and may not generate
positive cash flow for us.
Several customers account for a significant portion of our revenue.
We have substantial business relationships with a few large customers. For
the year ended December 31, 2001, our top ten customers accounted for
approximately 47% of our total revenue. Excluding the impact of the
recognition of $37.0 million in non-recurring reciprocal compensation revenue,
our top ten customers accounted for 44% of revenue in 2001. Our largest
customer for the year ended December 31, 2001, WorldCom Inc. and its
affiliates, accounted for 12% of our total revenue. However, a portion of that
revenue results from traffic that is directed to us by customers that have
selected WorldCom Inc. as their long distance carrier. No other customer,
including customers who direct their business through long distance carriers,
accounted for 10% or more of revenue in 2001. In 2001, the four companies that
individually represented more than 5% of total revenue, were WorldCom Inc.,
AT&T Corp., SBC Communications Inc., and Qwest Communications Inc. However,
excluding the impact of non-recurring reciprocal compensation, revenue from
SBC Communications Inc. represented less than 5% of total 2001 revenue.
We are dependent on Time Warner Cable's permits, licenses, and rights-of-way.
We currently license a significant portion of our fiber optic capacity from
Time Warner Cable. Municipalities that regulate Time Warner Cable may or may
not seek to impose additional franchise fees or otherwise charge Time Warner
Cable for the capacity we license. We must reimburse Time Warner Cable for any
new fees or increases in existing fees. Time Warner Cable or the Company may
not be able to obtain all necessary permits, licenses, or agreements from
governmental authorities or private rights-of-way providers necessary to
effect future license transactions. This would hinder our ability to expand
our existing networks or develop new networks successfully in locations served
by Time Warner Cable.
Our quarterly operating results will fluctuate.
As a result of the limited revenue and significant expenses associated with
the expansion and development of our networks and services, we anticipate that
our operating results could vary significantly from quarter to quarter.
Changes in the usage or payment patterns of significant customers and customer
bankruptcies may also cause operating results to vary.
We depend on third party vendors for information systems.
We have entered into agreements with vendors that provide for the
development and operation of back office systems, such as ordering,
provisioning, and billing systems. The failure of those vendors to perform
their services in a timely and effective manner at acceptable costs could have
a material adverse effect on our growth and our ability to monitor costs, bill
customers, provision customer orders, and achieve operating efficiencies.
If we do not adapt to rapid changes in the telecommunications industry, we
could lose customers or market share.
The telecommunications industry has experienced, and is expected to
continue to experience, rapid and significant changes in technology. While we
believe that, for the foreseeable future, these changes will neither
materially affect the continued use of fiber optic cable or digital switches
and transmission equipment, nor materially hinder our ability to acquire
necessary technologies, we cannot predict the effect of technological changes
on the Company's business and operations. We believe that our future success
will depend, in part, on our ability to anticipate or adapt to these changes
and to offer, on a timely basis, services that meet customer demands on a
competitive basis. There can be no assurance that we will obtain access to new
technologies on a timely basis or on satisfactory terms. Our failure to obtain
new technologies could have a material adverse impact on our business,
financial condition, and results of operations.
20
We are controlled by the Class B Stockholders.
Subsidiaries of AOL Time Warner Inc. and affiliates of Advance/Newhouse
Partnership, the Class B Stockholders, hold all the outstanding shares of the
Company's Class B common stock. At February 28, 2002, the AOL Time Warner
stockholder group holds 71.1% of the Company's voting power and 43.9% of its
outstanding common stock. The Advance/Newhouse stockholder group holds 22.0%
of the Company's voting power and 13.6% of its outstanding common stock. The
Class B Stockholders generally have the collective ability to control all
matters requiring stockholder approval, including the nomination and election
of directors. The Class B common stock is not subject to any mandatory
conversion provisions other than pursuant to certain transfer restrictions.
The disproportionate voting rights of the Class B common stock relative to the
Class A common stock may delay or prevent a change in control of the Company,
and may make us a less attractive takeover target.
Our Board of Directors consists of nine director positions. We currently
have one vacancy due to the resignation in November 2001 of William Schleyer,
an independent director. Under the Stockholders' Agreement, the AOL Time
Warner stockholder group has the right to designate four nominees for the
Board of Directors and the Advance/Newhouse stockholder group has the right to
designate one nominee. Under the Stockholders' Agreement, Class B Stockholders
agree to vote in favor of all nominees selected by the Class B Stockholders.
Class B Stockholders will also have the power to elect the other members of
our Board of Directors.
Each of the Class B Stockholders has veto rights over certain actions.
Under our Restated Certificate of Incorporation, as long as the outstanding
Class B common stock represents at least 50% of the aggregate voting power of
both classes of common stock outstanding, the approval of 100% of the Class B
Stockholders is required:
. to permit us to provide residential services or content services prior
to May 2004;
. to amend our Restated Certificate of Incorporation, other than in
connection with certain ministerial actions; or
. for any direct or indirect disposition by us of capital stock of
subsidiaries or assets that in either case represents substantially all
our assets on a consolidated basis.
The approval of 100% of the Class B Stockholders is also required for the
issuance of any additional shares of Class B common stock or any capital stock
having more than one vote per share.
The holders of Class B common stock can sell control of the Company at a time
when they do not have a majority economic interest in the Company, and
exclude the holders of Class A common stock from participating in the sale.
The Stockholders' Agreement provides that, subject to the rights of first
refusal of the other holders of Class B common stock, the Class B Stockholders
may transfer their Class B common stock. If a holder sells all, but not less
than all, of its Class B common stock as shares of Class B common stock, such
holder may transfer its right to nominate Class B nominees for election to the
Board of Directors. In addition, all of the holders of Class B common stock
have the right to participate in certain sales by the AOL Time Warner
stockholder group of its Class B common stock. Accordingly, majority control
of the Company could be transferred by one or more holders of Class B common
stock at a time when such holder or holders of Class B common stock do not
have a majority of the economic interest in the Company and with no assurance
that the holders of Class A common stock would be given the opportunity to
participate in the transaction, or if they were permitted to participate in
the transaction, to receive the same amount and type of consideration for
their stock in the Company as the holders of Class B common stock.
In addition, we have elected not to be subject to Section 203 of the
Delaware General Corporation Law, which would otherwise provide certain
restrictions on "business combinations" between us and any person
21
acquiring a significant, 15% or greater, interest in us other than in a
transaction approved by our Board of Directors and in certain cases by our
stockholders.
The Class B Stockholders may compete with us.
The Class B Stockholders are diversified communications providers. There is
no restriction on the Class B Stockholders' ability to compete with us. They
may, now or in the future, provide the same or similar services to those that
we provide.
Some of our directors may have conflicts of interest.
Some of our directors are also directors, officers, or employees of the
Class B Stockholders or their affiliates. Although these directors have
fiduciary obligations to the Company under Delaware law, they may face
conflicts of interest. For example, conflicts of interest may arise with
respect to certain business opportunities available to, and certain
transactions involving, the Company. The Class B Stockholders have not adopted
any special voting procedures to deal with such conflicts of interest. The
resolution of these conflicts may be unfavorable to us. Our Restated
Certificate of Incorporation provides for the allocation of corporate
opportunities between the Class B Stockholders and us.
We will experience a reduction in switched access and reciprocal compensation
revenue as a result of regulatory rate reform.
The FCC has established a framework for the regulation of CLEC interstate
access charges, which has reduced, and will continue to reduce, our interstate
access rates. In addition, the FCC has established an interim carrier-to-
carrier cost recovery scheme for dial-up Internet traffic that has reduced,
and will continue to reduce, the Company's reciprocal compensation. The FCC is
considering replacing the current intercarrier compensation scheme with bill
and keep at some time in the future, which would eliminate the Company's
switched access and reciprocal compensation revenue. Exclusive of the effects
of the recognition of $37.0 million in non-recurring reciprocal compensation,
switched access and reciprocal compensation represented 7% and 6%,
respectively, of the Company's 2001 revenue. The Company anticipates that the
contribution to revenue and EBITDA from these services will decline over time.
We cannot assure, however, that we will be able to compensate for the
reduction in switched access and reciprocal compensation revenue from
regulatory rate reform with other revenue sources or increased volume.
We may complete a significant business combination or other transaction that
could affect our leverage, result in a change in control, or both.
We continually evaluate potential business combinations, joint ventures,
and other transactions that would extend our geographic markets, expand our
services, or enlarge the capacity of our networks. Any material transaction
that we undertake could result in an increase in our leverage or issuing
additional common stock or both, or a change of control. There can be no
assurance, however, that we will enter into any transaction or, if we do, on
what terms.
A change of control could result in a requirement that we offer to purchase
certain indebtedness and the acceleration of other indebtedness. There can be
no assurance that we will have sufficient funds available to make that
repurchase and repay any accelerated indebtedness.
We depend on governmental and other authorizations.
The development, expansion, and maintenance of our networks will depend on,
among other things, our ability to obtain rights-of-way and other required
governmental authorizations and permits. Any increase in the difficulty or
cost of obtaining these authorizations and permits could adversely affect us,
particularly in areas where we must compete with companies that already have
the necessary permits. In order to compete effectively,
22
we must obtain these authorizations in a timely manner, at reasonable costs,
and on satisfactory terms and conditions. In certain cities or municipalities
where we provide network services, we pay license or franchise fees. The 1996
Act permits municipalities to charge these fees only if they are competitively
neutral and nondiscriminatory, but certain municipalities may not conform
their practices to the requirements of the 1996 Act in a timely manner or
without legal challenge. We also face the risks that other cities may start
imposing fees, fees will be raised, or franchises will not be renewed. Some of
our franchise agreements also provide for increases or renegotiation of fees
at certain intervals. Any increases in these fees may have a negative impact
on our financial condition.
Item 2. Properties
The Company leases network hub sites and other facility locations and sales
and administrative offices, many from Time Warner Cable, in each of the cities
in which the Company operates networks. During 2001, 2000, and 1999, rental
expense for the Company's facilities and offices totaled approximately $27.5
million, $15.2 million, and $6.6 million, respectively. In 2001, the Company
terminated an agreement to purchase 24 acres in Douglas County, Colorado, for
construction of a campus for its Denver headquarters. Management believes that
its properties, taken as a whole, are in good operating condition and are
suitable and adequate for the Company's business operations. The Company
currently leases approximately 94,000 square feet of space in Littleton,
Colorado, where its corporate headquarters are located, and approximately
130,000 square feet of space in Greenwood Village, Colorado and approximately
70,000 square feet of space in Englewood, Colorado, where its network
operations center and other administrative functions are located.
Item 3. Legal Proceedings
The Company currently has no material legal proceedings pending.
Item 4. Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of security holders during the quarter
ended December 31, 2001.
23
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
Market Information
The Company's Class A common stock has traded on the Nasdaq National Market
under the symbol "TWTC" since May 12, 1999. The following table sets forth the
high and low sales prices for the Class A common stock for each of the
quarters of 2001 and 2000 as reported on the Nasdaq National Market:
Period High Low
------ ------- -------
2001
First Quarter................................................ $78.125 $35.063
Second Quarter............................................... 55.150 24.500
Third Quarter................................................ 33.800 6.820
Fourth Quarter............................................... 19.500 5.760
2000
First Quarter................................................ $93.000 $39.500
Second Quarter............................................... 80.375 41.000
Third Quarter................................................ 73.750 42.250
Fourth Quarter............................................... 71.750 46.250
Dividends
The Company has never paid or declared any dividends and does not
anticipate paying any dividends in the foreseeable future. The decision
whether to pay dividends will be made by the Company's Board of Directors in
light of conditions then existing, including the Company's results of
operations, financial condition and requirements, business conditions,
covenants under loan agreements and other contractual arrangements, and other
factors. In addition, the indentures for the Company's 9 3/4% and 10 1/8%
Senior Notes and the credit agreement governing its senior secured credit
facility contain covenants that effectively prevent the Company from paying
dividends on the common stock for the foreseeable future.
Number of Stockholders
As of February 28, 2002, there were 258 holders of record of the Company's
Class A common stock and eight holders of record of the Class B common stock.
The Company believes that there are in excess of 18,500 beneficial owners of
the Company's Class A common stock in addition to the record owners.
24
Item 6. Selected Financial Data
Selected Consolidated and Combined Financial and Other Operating Data
The following table is derived in part from the audited consolidated
financial statements of the Company. The financial statements of the Company
for all periods prior to the Reorganization reflect the "carved out"
historical financial position, results of operations, cash flows, and changes
in stockholders' equity of the commercial telecommunications operations of
predecessors of the Company, as if they had been operating as a separate
company. This information should be read in conjunction with "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
the audited consolidated financial statements and the notes thereto.
Years Ended December 31,
--------------------------------------------------------
2001 2000 1999 1998 1997
---------- ---------- --------- --------- ---------
(in thousands, except per share and operating data
amounts)
Statements of Operations
Data:
Revenue:
Dedicated transport
services.............. $ 425,401 263,913 152,468 84,024 44,529
Switched services(1)... 312,306 223,421 116,285 37,848 10,872
---------- ---------- --------- --------- ---------
Total revenue........ 737,707 487,334 268,753 121,872 55,401
---------- ---------- --------- --------- ---------
Costs and expenses(2):
Operating.............. 315,682 184,995 117,567 67,153 40,349
Selling, general, and
administrative........ 237,698 170,722 113,389 77,401 54,640
Depreciation and
amortization.......... 207,571 95,295 68,785 50,717 38,466
Restructure
charge(3)............. 6,838 -- -- -- --
---------- ---------- --------- --------- ---------
Total costs and
expenses............ 767,789 451,012 299,741 195,271 133,455
---------- ---------- --------- --------- ---------
Operating income
(loss)................. (30,082) 36,322 (30,988) (73,399) (78,054)
Interest (expense), net,
and other income....... (99,341) (30,409) (28,473) (19,340) 7,398
---------- ---------- --------- --------- ---------
Net income (loss) before
income taxes........... (129,423) 5,913 (59,461) (92,739) (70,656)
Income tax expense
(benefit)(4)........... (48,256) 4,697 29,804 -- --
---------- ---------- --------- --------- ---------
Net income (loss)....... $ (81,167) $ 1,216 (89,265) (92,739) (70,656)
========== ========== ========= ========= =========
Basic and diluted
earnings (loss) per
share.................. $ (0.71) $ 0.01 (0.93) (1.14) (0.87)
========== ========== ========= ========= =========
Other Operating Data:
EBITDA(1)(5)............ $ 177,489 131,617 37,797 (22,682) (39,588)
EBITDA margin(1)(6)..... 24% 27% 14% (19)% (72)%
Net cash provided by
(used in) operating
activities............. $ 197,234 165,259 54,235 (343) (29,419)
Capital expenditures.... 425,452 320,703 221,224 126,023 127,315
Operating Data(7)
Operating networks...... 44 24 21 19 19
Route miles............. 16,806 9,799 8,872 6,968 5,913
Fiber miles............. 758,060 366,990 332,263 272,390 233,488
DS-0 equivalents(8)..... 16,736,000 11,375,000 5,523,000 3,031,000 1,719,000
Digital telephone
switches............... 41 26 19 16 14
Employees............... 2,661 1,834 1,259 919 714
Balance Sheet Data:
Cash, cash equivalents,
and cash held in
escrow................. $ 365,600 250,739 90,586 105,140 --
Marketable debt
securities............. 18,454 3,496 173,985 250,857 --
Property, plant, and
equipment, net......... 1,811,096 912,172 677,106 494,158 415,158
Total assets............ 2,398,954 1,387,754 1,043,012 904,344 438,077
Long-term debt and
capital lease
obligations............ 1,063,368 585,107 403,627 574,940 75,475
Total stockholders'
equity................. $ 948,713 471,767 422,916 207,651 300,390
- --------
(1) Includes favorable non-recurring reciprocal compensation settlements that
totaled $37.0 million in 2001, $27.3 million in 2000, and $7.6 million in
1999.
25
(2) Includes expenses resulting from transactions with affiliates of $17.7
million, $15.6 million, $20.0 million, $27.7 million, and $17.1 million in
2001, 2000, 1999, 1998, and 1997, respectively. See Note 6 to the
Company's financial statements appearing elsewhere in this report for an
explanation of these expenses.
(3) Includes $2.4 million for a non-cash facilities impairment.
(4) During 1999, the Company recorded a non-recurring $39.4 million charge to
earnings to establish a net deferred tax liability associated with the
change from a limited liability company to a corporation. This change
occurred immediately prior to the Company's IPO.
(5) "EBITDA" is defined as operating income (loss) before depreciation and
amortization expense. It does not include charges for interest expense or
provision for income taxes. Accordingly, EBITDA is not intended to replace
operating income (loss), net income (loss), cash flow, and other measures
of financial performance and liquidity reported in accordance with
accounting principles generally accepted in the United States. Rather,
EBITDA is a measure of operating performance and liquidity that investors
may consider in addition to such measures. Management believes that EBITDA
is a standard measure of operating performance and liquidity that is
commonly reported and widely used by analysts, investors, and other
interested parties in the telecommunications industry because it
eliminates many differences in financial, capitalization, and tax
structures, as well as non-cash and non-operating charges to earnings.
EBITDA is used internally by the Company's management to assess on-going
operations and is a measure used to test compliance with certain covenants
of the 9 3/4% Senior Notes, the 10 1/8% Senior Notes, and the Company's
secured credit facility. However, EBITDA as used in this report may not be
comparable to similarly titled measures reported by other companies due to
differences in accounting policies.
(6) EBITDA margin represents EBITDA as a percentage of revenue.
(7) Includes all managed properties including unconsolidated affiliates
(MetroComm AxS, L.P. in Columbus, Ohio and the Albany and Binghamton, New
York networks). Albany and Binghamton were wholly owned at December 31,
1997 and MetroComm AxS, L.P. was wholly owned at December 31, 1999.
(8) Each DS-0 equivalent provides 64 kilobits per second of bandwidth.
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations
The following discussion and analysis should be read in conjunction with
the Company's audited consolidated financial statements, including the notes
thereto, appearing elsewhere in this report.
Overview
The Company is a leading fiber facilities-based provider of metropolitan
and regional optical broadband networks and services to business customers.
The Company delivers broadband data, dedicated Internet access, and local and
long distance voice services. As of December 31, 2001, the Company served
customers in 44 metropolitan markets in the United States.
Time Warner Cable (now a unit of AOL Time Warner Inc.) began the Company's
business in 1993. During the last few years, the Company's business has
changed substantially with an exclusive focus on business customers, including
carriers and governmental entities, and a rapid expansion into switched
services and geographic areas beyond the Time Warner Cable footprint.
In May 1999, in preparation for the Company's IPO, TWT LLC was
reconstituted as a Delaware corporation under the name Time Warner Telecom
Inc. The outstanding limited liability company interests were converted into
common stock of the newly formed corporation, Time Warner Telecom Inc. In May
1999, in conjunction with the Reconstitution, the Company completed its IPO of
20,700,000 shares of Class A common stock at a price of $14 per share.
As a result of the IPO, the Company has two classes of common stock
outstanding, Class A common stock and Class B common stock. In general,
holders of Class A common stock have one vote per share and holders of Class B
common stock have ten votes per share. Each share of Class B common stock is
convertible, at the option
26
of the holder, into one share of Class A common stock. Holders of Class A
common stock and Class B common stock generally vote together as a single
class. However, some matters require the approval of 100% of the holders of
the Class B common stock voting separately as a class, and some matters
require the approval of a majority of the holders of the Class A common stock,
voting separately as a class. As of December 31, 2001, the Class B
Stockholders had approximately 93.1% of the combined voting power of the
outstanding common stock.
On January 25, 2001, the Company completed a public offering of 7,475,000
shares of Class A common stock at a price of $74 7/16 per share (the
"Offering"). The Offering generated $532 million in proceeds for the Company,
net of underwriting discounts and expenses. Also on January 25, 2001, the
Company completed a private placement of $400 million principal amount of 10
1/8% Senior Notes due February 2011 (the "Old Notes"). Pursuant to an exchange
offer in March 2001, all of the holders of the Old Notes exchanged their Old
Notes for new 10 1/8% Senior Notes due February 2011 (the "10 1/8% Senior
Notes") with the same financial terms that were registered under the
Securities Act of 1933. The Company used all of the net proceeds from the
Offering and a portion of the net proceeds from the offering of the Old Notes
to repay the $700 million senior unsecured bridge facility that initially
financed the acquisition of substantially all of the assets of GST.
The Company operates in metropolitan areas that have high concentrations of
medium- and large-sized businesses. Historically, the Company has focused its
sales and marketing efforts on such businesses, as they are potentially high
volume users of the Company's services. The Company's revenue has been derived
primarily from business telephony services, including dedicated transport,
local switched, long distance, data, and high-speed Internet access services.
On January 10, 2001, the Company expanded its geographic coverage by
acquiring substantially all of the assets of GST out of bankruptcy. See
"Acquisitions" below. Additionally, the Company activated networks in Chicago,
Illinois; Atlanta, Georgia; Minneapolis, Minnesota; Denver, Colorado; and
Columbia, South Carolina during 2001. As of December 31, 2001, the Company's
networks spanned 16,806 route miles, contained 758,060 fiber miles, and
offered service to 10,685 on-net and off-net buildings in 21 states, including
4,210 route miles, 227,674 fiber miles, and service to 345 on-net buildings in
15 western markets acquired from GST. The Company continues to expand its
footprint within its existing markets by expanding its network into new
buildings. The Company is also selectively interconnecting existing service
areas within regional clusters with owned or leased fiber optic facilities and
has launched on-net inter-city switched services that provide customers the
ability to offer a virtual presence in a remote city.
The Company plans to continue expanding its revenue base by utilizing
available network capacity in its existing markets, by servicing additional
buildings in existing markets, and by continuing to develop and selectively
tailor new services in competitively-priced packages to meet the needs of its
medium- and large-sized business customers. The Company intends to expand its
service offerings on a continuous basis to achieve a diverse revenue base. The
Company's goal is to deploy new services and technologies when technically
proven and when customer demand is evident. As new technologies that enable
the switching of voice calls over an IP and LAN infrastructure are becoming
commercially viable, the Company is integrating this softswitch technology
into its infrastructure. There is no assurance that the Company will bring any
or all of these services to market successfully or profitably.
As part of the process of diversifying its revenue base, the Company is
targeting the expansion of data and Internet services offered on the Company's
existing network. The Company's annual revenue from data and Internet services
for 2001 grew 98% over 2000 and represented 9% of the Company's total revenue
for 2001. The Company expects an increasing portion of its future revenue to
be contributed by data and Internet services.
Due to the impacts of a slowing economy, which has resulted in customers
going out of business, filing bankruptcies, or looking for opportunities to
cut costs, the Company has experienced an acceleration of customers
disconnecting services that has resulted in downward pressure on revenue
performance. In addition, retail customers are taking longer to make buying
decisions, lengthening the sales cycle. During 2001, monthly recurring revenue
of nearly $15 million was eliminated due to customer disconnects and
bankruptcies.
27
Management believes that this pressure is likely to continue to negatively
impact revenue performance for several quarters. Less than 4% of the Company's
monthly recurring revenue at December 31, 2001 was represented by customers
that had filed bankruptcy proceedings. Since December 31, 2001, additional
customers filed bankruptcy proceedings, bringing the total percentage of
monthly recurring revenue from customers in bankruptcy to approximately 5%.
The Company cannot predict how much of that revenue will be lost to
disconnections. In addition, the Company anticipates further disconnections by
other customers due to their optimizing their existing networks, continued
cost cutting efforts, and additional customer bankruptcies or other customer
financial difficulties. Although the Company was able to replace revenue lost
to customer disconnections in 2001 with revenue from new sales, there is no
assurance that the Company will be able to continue to do so.
Factors that could negatively impact the Company's margins in a slowing
economy include below-cost pricing by some competitors to increase short-term
revenue and pressure on long distance rates, both of which represent a
relatively small percentage of the Company's revenue. In addition, pricing
pressure from long haul providers could impact pricing of inter-city point-to-
point services, and the Company has seen intense price competition in common
POP to POP locations in central business districts in certain cities. However,
the Company believes that its margins are improved by its ability to sell
services on its extensive networks that extend beyond these types of highly
competitive routes.
While bankruptcies in the telecommunications and ISP sectors present a
threat to revenue growth, the contraction in the number of providers may
benefit the Company in the following respects:
. as some emerging providers go out of business, their customers may seek
to purchase services from the Company;
. the failure of some emerging telecommunications providers may reduce
some of what the Company believes is artificially low pricing of
services that exists in the market for certain telecommunications
services; and
. the availability of experienced telecommunications personnel may
improve.
There is no assurance that the Company will realize any benefits from the
downturn in these sectors or that the Company will not be adversely affected
by conditions in its market sectors or the economy in general.
Reciprocal compensation revenue is an element of switched services revenue
that represents compensation from LECs for local exchange traffic originated
on another LEC's facilities and terminated on the Company's facilities.
Reciprocal compensation rates are established by interconnection agreements
between the parties based on regulatory and judicial rulings in each of the
states. Several significant agreements expired in 2001 and have been
renegotiated. In most of the states, regulatory bodies have established lower
traffic termination rates than the rates provided under the Company's expired
agreements; and as a result, the rates under the new agreements, while
reasonable in light of the regulatory environment, are lower than the rates
under the expired agreements. In addition, a 2001 FCC ruling on reciprocal
compensation for ISP-bound traffic reduced rates in 2001 and will further
reduce rates in January 2002 and June 2003. The ruling also capped the number
of minutes charged for ISP-bound traffic. Reciprocal compensation represented
approximately 6% of revenue, exclusive of the effects of the recognition of
$37.0 million, $27.3 million, and $7.6 million of non-recurring reciprocal
compensation, in each of 2001, 2000, and 1999, respectively.
Switched access is the connection between a long distance carrier's POP and
an end user's premises provided through the switching facilities of a LEC.
Historically, the FCC has regulated the access rates imposed by the ILECs,
while the CLEC access rates have been less regulated. The FCC released an
order effective in June 2001 that subjects CLECs' interstate switched access
charges to regulation. Effective with that order, the Company's rates were
reduced and will continue to decline over a three-year period to parity with
the ILEC rates competing in each area. In addition, when a CLEC enters a new
market, its access charges may be no higher than the ILEC's. This order does
not affect rates pursuant to contracts between the Company and certain long
distance carriers.
28
The Company and several other CLECs have filed petitions with the FCC for
reconsideration of the provisions of the order relating to new markets, and
other carriers have challenged the order in federal court. There is no
assurance that any legal challenge will be successful or that a successful
challenge will change the trend toward lower access charges. The CLEC access
charge regulation and related regulatory developments resulted in reductions
in the per-minute rates the Company receives for switched access service in
2001 and will result in further reductions in June 2002 and June 2003. In
addition, the Company has contracts with certain carriers that have access
rate reductions in relationship to volume commitments. There is no assurance
that the Company will be able to compensate for reductions in switched access
revenue resulting from the FCC order with revenue from other sources. Switched
access revenue represented 7%, 11%, and, 12% of total revenue, exclusive of
the effects of the recognition of non-recurring reciprocal compensation
discussed above in the years ended December 31, 2001, 2000, and 1999,
respectively.
The Company benefits from its strategic relationship with Time Warner Cable
both through access to local rights-of-way and construction cost-sharing. Of
the Company's 44 networks, 23 have been constructed substantially through the
use of fiber capacity licensed from Time Warner Cable. In the normal course of
business, the Company engages in various transactions with AOL Time Warner
Inc. and its affiliates, generally on negotiated terms among the affected
units that, in management's view, result in reasonable arms-length terms. The
Company entered into several contracts with these affiliates with respect to
certain of these transactions. The Company's dedicated transport and switched
services revenue includes services provided to AOL Time Warner Inc. and its
affiliates. The Company's selling, general, and administrative expenses
include charges from affiliates of AOL Time Warner Inc. for office rent and
overhead charges for limited administrative functions they perform for the
Company. In addition, the Company licenses the right to use a significant
portion of its local fiber capacity from Time Warner Cable through prepaid
right-to-use agreements and reimburses Time Warner Cable for facility
maintenance and pole rental costs. The maintenance and pole rental costs are
included in the Company's operating expenses. The Company believes that as a
result of certain recent regulatory decisions regarding the pole rental rates
that Time Warner Cable passes through to the Company, there is a risk that the
Company's expenses for these items could increase over time. The Company also
benefits from discounts available to AOL Time Warner Inc. and its affiliates
by aggregating its purchases of certain goods and services with those of AOL
Time Warner Inc., including long distance services, car rental services,
overnight delivery services, and wireless usage.
Acquisitions
On January 10, 2001, the Company completed the acquisition of substantially
all of the assets of GST out of bankruptcy for a contractual purchase price of
$690 million. The $690 million included payments to GST or third parties on
behalf of GST totaling approximately $662 million, the assumption of
approximately $21 million in obligations to complete certain fiber networks,
and a liability to provide transitional services to GST of approximately $7
million. In addition to the $690 million contractual purchase price, the
Company paid approximately $6 million in transaction expenses and assumed
approximately $17 million in liabilities primarily related to capital leases.
As a result of this acquisition, the Company added 15 markets, approximately
4,210 route miles, and approximately 227,674 fiber miles in the western United
States.
In connection with the GST asset acquisition, the Company completed the
integration of the financial, sales, marketing, and field operations
functions. The Company activated a regional fiber network covering
approximately 4,100 miles that was under construction at the time of the GST
asset acquisition and has begun expanding the metropolitan networks in several
of the acquired markets. The Company expects that the integration of back
office systems and network operations will be complete by year-end 2002.
The Company's acquisition of the GST assets increased its geographic
presence, expanded its service offerings, and enlarged the capacity of its
networks. This transaction is considerably larger than the transactions the
Company has completed in the past and therefore presents risks related to the
integration of the back office systems and a diversion of resources away from
the Company's existing operations. The Company completed the acquisition with
the expectation that the asset purchase would result in certain efficiencies.
Achieving the benefits
29
of the asset purchase will depend upon the successful completion of the
integration and the generation of new revenue from the acquired markets. In
addition, the GST assets were purchased out of bankruptcy and required the
replacement and training of new sales staff, and further build-out of networks
in order to perform to the standards of the Company's other markets. There is
no assurance that the Company will be successful in fully integrating the
acquired GST assets into its current businesses or that significant additional
revenue from those assets will be generated.
During the second quarter of 1999, the Company acquired all of the
outstanding common stock of Internet Connect, Inc., an ISP, for consideration
consisting of $3.8 million of Class A limited liability interests in TWT LLC,
the Company's predecessor, approximately $3.5 million in net cash, and the
assumption of $1.9 million in liabilities. At the time of the IPO, these Class
A limited liability interests were converted into 307,550 shares of Class A
common stock of the Company that were placed in escrow and are being released
to the former Internet Connect, Inc. shareholders over a period of three years
beginning in April 2000.
During the second quarter of 1999, the Company acquired all of the
outstanding common stock of MetroComm, Inc. through the issuance of 2,190,308
shares of Class A common stock of the Company valued at $24.1 million, and the
assumption of $20.1 million in liabilities. Through the acquisition of
MetroComm Inc., the Company acquired the 50% interest of MetroComm AxS, L.P.,
a CLEC in Columbus, Ohio, not already owned by the Company.
Results of Operations
The Company's operating expenses consist of costs directly related to the
operation and maintenance of the networks and the provision of the Company's
services. These costs include the salaries and related expenses of operations
and engineering personnel, as well as costs incurred from the ILECs, other
competitors, and long distance providers for facility leases and
interconnection. These costs have increased over time as the Company has
increased its operations and revenue. The Company expects such costs to
continue to increase if the Company's revenue growth continues, although the
Company may seek to control its personnel costs where appropriate. The fact
that the Company carries a significant portion of its traffic on its own fiber
infrastructure enhances the Company's ability to control its costs.
Selling, general, and administrative expenses consist of salaries and
related costs for employees other than those involved in operations and
engineering. Such expenses include costs related to sales and marketing,
information technology, billing, regulatory, and legal costs. These costs have
increased over time as the Company has increased its operations and revenue.
The Company expects these costs to continue to increase if the Company's
revenue growth continues, although the Company may seek to control its
personnel costs where appropriate.
30
The following table sets forth certain data from the Company's consolidated
financial statements presented in thousands of dollars and expressed as a
percentage of total revenue. This table should be read together with the
Company's audited financial statements, including the notes thereto, appearing
elsewhere in this report:
Years Ended December 31,
-----------------------------------------------
2001 2000 1999
---------------- ------------- -------------
(amounts in thousands, except per share
amounts)
Statements of Operations
Data:
Revenue:
Dedicated transport
services.................. $ 425,401 58 % 263,913 54 152,468 57
Switched services(1)....... 312,306 42 223,421 46 116,285 43
----------- --- -------- --- -------- ---
Total revenue............ 737,707 100 487,334 100 268,753 100
----------- --- -------- --- -------- ---
Costs and expenses(2):
Operating.................. 315,682 43 184,995 38 117,567 44
Selling, general and
administrative............ 237,698 32 170,722 35 113,389 42
Depreciation and
amortization.............. 207,571 28 95,295 20 68,785 25
Restructure charge(3)...... 6,838 1 -- -- -- --
----------- --- -------- --- -------- ---
Total costs and
expenses................ 767,789 104 451,012 93 299,741 111
----------- --- -------- --- -------- ---
Operating income (loss)...... (30,082) (4) 36,322 7 (30,988) (11)
Interest expense(2).......... (115,080) (16) (41,230) (8) (45,264) (17)
Interest income.............. 18,703 2 10,821 2 16,589 6
Investment losses, net....... (2,964) -- -- -- -- --
Equity in income (losses) of
unconsolidated affiliate.... -- -- -- -- 202 --
----------- --- -------- --- -------- ---
Net income (loss) before
income taxes................ (129,423) (18) 5,913 1 (59,461) (22)
Income tax expense
(benefit)(4)................ (48,256) (7) 4,697 1 29,804 11
----------- --- -------- --- -------- ---
Net income (loss)............ $ (81,167) (11)% 1,216 -- (89,265) (33)
=========== === ======== === ======== ===
Basic and diluted earnings
(loss) per common share..... $ (0.71) 0.01 (0.93)
Weighted average shares
outstanding:
Basic........................ 113,730 105,391 95,898
Diluted...................... 113,730 108,452 95,898
EBITDA(1)(5)................. 177,489 24% 131,617 27 37,797 14
Net cash provided by
operating activities........ 197,234 165,259 54,235
Net cash used in investing
activities.................. (1,087,806) (178,592) (146,917)
Net cash provided by
financing activities......... 1,005,433 173,486 78,128
- --------
(1) Includes favorable non-recurring reciprocal compensation settlements that
totaled $37.0 million in 2001, $27.3 million in 2000, and $7.6 million in
1999.
(2) Includes expenses resulting from transactions with affiliates of $17.7
million, $15.6 million, and $20.0 million in 2001, 2000, and 1999,
respectively.
(3) Includes a $2.4 million non-cash facilities impairment charge.
(4) During 1999, the Company recorded a non-recurring $39.4 million charge to
earnings to establish a net deferred tax liability associated with the
change from a limited liability company to a corporation. This change
occurred immediately prior to the Company's IPO.
(5) "EBITDA" is defined as operating income (loss) before depreciation and
amortization expense. It does not include charges for interest expense or
provision for income taxes. Accordingly, EBITDA is not intended to replace
operating income (loss), net income (loss), cash flow, and other measures
of financial performance and liquidity reported in accordance with
accounting principles generally accepted in the United States. Rather,
EBITDA is a measure of operating performance and liquidity that investors
may consider in addition to such measures. Management believes that EBITDA
is a standard measure of operating performance and
31
liquidity that is commonly reported and widely used by analysts, investors,
and other interested parties in the telecommunications industry because it
eliminates many differences in financial, capitalization, and tax
structures, as well as non-cash and non-operating charges to earnings.
EBITDA is used internally by the Company's management to assess on-going
operations and is a measure used to test compliance with certain covenants
of the 9 3/4% Senior Notes, the 10 1/8% Senior Notes, and the Company's
secured revolving credit facility. However, EBITDA as used in this report
may not be comparable to similarly titled measures reported by other
companies due to differences in accounting policies.
Critical Accounting Policies
The consolidated financial statements are prepared in accordance with
accounting principles generally accepted in the United States, which require
the Company to make estimates and assumptions. The Company believes that of
its significant accounting policies, which are described in Note 1 to the
consolidated financial statements included herein, the following involved a
higher degree of judgment and complexity, and are therefore considered
critical.
Revenue Recognition. Revenue for dedicated transport, data, Internet, and
the majority of switched services exclusive of switched access is generally
billed in advance on a fixed rate basis and recognized over the period the
services are provided. Revenue for the majority of switched access and long
distance is generally billed on a transactional basis determined by customer
usage with some fixed rate elements. The transactional elements of switched
services are billed in arrears and estimates are used to recognize revenue in
the period earned. The fixed rate elements are billed in advance and
recognized over the period the services are provided.
Reciprocal compensation is based on contracts between the Company and other
LECs. The Company recognizes reciprocal compensation revenue as it is earned,
except in those cases where the revenue is under dispute or at risk.
Reciprocal compensation is an element of switched services revenue and
includes the recognition of $37.0 million, $27.3 million, and $7.6 million, of
non-recurring reciprocal compensation for 2001, 2000, and 1999, respectively.
Significant portions of these non-recurring revenues were recognized upon the
resolution of disputes between the Company and other LECs. As of December 31,
2001, the Company had deferred recognition of $28.0 million in reciprocal
compensation revenue for payments in dispute that may be subject to refund or
adjustment. The Company pays reciprocal compensation expense to other LECs for
local exchange traffic it terminates on the LECs' facilities. These costs are
recognized as incurred.
Receivables. The Company does not require significant collateral for
services provided to customers. However, the Company performs ongoing credit
evaluations of its customers' financial conditions and has provided an
allowance for doubtful accounts based on the expected collectability of all
accounts receivable. If the financial condition of our customers deteriorates,
additional allowances may be required. The allowance for doubtful accounts was
$29.8 million and $17.6 million at December 31, 2001 and 2000, respectively.
Impairment of Long-Lived Assets. The Company periodically reviews the
carrying amounts of property, plant, and equipment and its intangible assets
to determine whether current events or circumstances warrant adjustments to
the carrying amounts. As part of this review, management analyzes the budgeted
undiscounted cash flows associated with its property, plant, and equipment and
its intangible assets. Considerable management judgment is necessary to
complete this analysis. Although management believes these estimates to be
reasonable, actual results could vary significantly from these estimates.
Variances in results could result in changes to the carrying value of the
Company's assets including, but not limited to, recording an impairment for
some of these assets in future periods. For the year ended December 31, 2001,
the Company recorded a $9.6 million in impairment of certain non-revenue
generating assets and a $2.4 million impairment of assets related to the
restructuring activities described below.
Deferred Taxes. At December 31, 2001, the Company had net operating loss
carryforwards for federal income tax purposes of approximately $293.9 million
for which no valuation allowance has been recorded. These net operating loss
carryforwards, if not utilized to reduce taxable income in future periods,
will expire in various
32
amounts beginning in 2019 and ending in 2021. The net deferred tax asset
recorded at December 31, 2001, was $59.2 million. The Company has analyzed and
will continue to analyze the sources and expected reversal periods of its
deferred tax assets. The Company has also identified and analyzed tax planning
strategies that can be employed to utilize net operating loss carryforwards.
The Company believes that the tax benefits attributable to deductible
temporary differences will be realized by recognition of future taxable
amounts. The Company plans to employ tax planning strategies to avoid losing
the benefit of any significant expiring net operating loss carryforward. The
Company's treatment of its deferred taxes and its tax planning strategies are
based on certain assumptions that the Company believes are reasonable.
However, actual results could vary significantly from current assumptions and
could result in changes to the accounting treatment of these items, including,
but not limited to, the necessity to record a valuation allowance for some or
all of the Company's deferred tax assets.
Year Ended December 31, 2001 Compared to Year Ended December 31, 2000
Revenue. Revenue increased $250.4 million or 51%, to $737.7 million for
2001, from $487.3 million for 2000. Revenue from the provision of dedicated
transport services increased $161.5 million or 61%, to $425.4 million for
2001, from $263.9 million for 2000. Switched service revenue increased $88.9
million or 40%, to $312.3 million for 2001, from $223.4 million for 2000.
Included in total revenue for 2001 is $8.6 million in services provided to the
GST bankruptcy estate and to transitional customers, which ceased during the
fourth quarter of 2001. Reciprocal compensation represented 6% of total
revenue for both 2001 and 2000, excluding the effects of the recognition of
$37.0 million and $27.3 million of non-recurring reciprocal compensation in
2001 and 2000, respectively. At December 31, 2001, the Company offered
dedicated transport services in 44 metropolitan areas, 42 of which also
offered switched services. At December 31, 2000, the Company offered dedicated
transport services in 24 metropolitan areas, all of which also offered
switched services.
Exclusive of the effects of the GST asset acquisition during 2001 and the
effects of the recognition of $37.0 million and $27.3 million of non-recurring
reciprocal compensation during 2001 and 2000, respectively, total revenue
increased $143.2 million or 31%, to $603.2 million, from $460.0 million for
the comparable period in 2000. Excluding the GST asset acquisition and non-
recurring reciprocal compensation, dedicated transport service and switched
service revenue increased 42% and 17%, respectively. The increase in dedicated
transport services revenue reflects an increase in the average number of
dedicated transport customers, including the impacts of adding five new
markets, and a broader array of services offered to existing customers. A 58%
increase in recurring reciprocal compensation and a 90% increase in Internet
revenue were the largest components accounting for the change in switched
services revenue. The increase in switched service revenue also reflects an
increase in the average number of switched service customers, including the
impacts of adding five new markets and a broader array of services offered to
existing customers. Switched access revenue decreased 6% in 2001 compared to
2000. Although revenue from reciprocal compensation increased over the prior
year, the average rates for both reciprocal compensation and switched access
have decreased and are expected to continue declining in the foreseeable
future as a result of regulatory rulings. In addition, the rate of increase of
dedicated transport and switched services revenue slowed as compared to the
1999 to 2000 period, primarily due to the impacts of the slowing economy, as
discussed above.
Operating Expenses. Operating expenses increased $130.7 million or 71%, to
$315.7 million for 2001, from $185.0 million for 2000. As a percentage of
total revenue, operating expenses increased to 43% for 2001 from 38% for 2000,
primarily as a result of the acquired assets and development of new markets.
Exclusive of the effects of the GST asset acquisition, operating expenses
increased $47.4 million or 26%. The increase was primarily attributable to a
$38.8 million increase in charges for circuit lease and other costs paid to
other carriers for the use of their facilities including leased facilities for
the IP backbone. Excluding the effects of the GST asset acquisition and the
recognition of non-recurring reciprocal compensation noted above, operating
expenses represented 39% of total revenue in 2001 compared to 40% in 2000.
33
Selling, General, and Administrative Expenses. Selling, general, and
administrative expenses increased $67.0 million or 39%, to $237.7 million for
2001, from $170.7 million for 2000. Selling, general, and administrative
expenses decreased to 32% of total revenue for 2001 from 35% for 2000.
Exclusive of the effects of the GST asset acquisition, selling, general, and
administrative expenses increased $23.4 million or 14%. The increase was
primarily attributable to an $18.4 million increase in net employee costs, a
$7.2 million increase in bad debt expense due to increased revenue and an
increase in customer bankruptcies, and a $5.7 million increase in property tax
expense due to a larger base of property, plant, and equipment. These
increases were partially offset by an $8.5 million decrease in systems
implementation expense, primarily due to a refocus in back office support
system initiatives. Excluding the effects of the GST asset acquisition and the
recognition of non-recurring reciprocal compensation noted above, selling,
general, and administrative expenses represented 32% of total revenue in 2001
compared to 37% in 2000.
Restructure Charge. In the fourth quarter of 2001, the Company recorded a
restructure charge of $6.8 million as a result of a decision to consolidate
its network operations centers by closing a facility in Vancouver, Washington
and eliminating approximately 200 positions. In addition, the Company decided
to consolidate its offices in Houston into one facility. These decisions were
made to create efficiencies in the Company's sales, billing, customer care,
network surveillance and maintenance processes, and to reduce overhead by
centralizing offices. The Company estimates that the restructuring will save
between $10 million and $14 million in operating costs per year without
materially impacting its revenues. The $6.8 million charge included the
following:
. $2.7 million in severance-related costs. Most of the 200 positions were
eliminated during the fourth quarter of 2001 and the first quarter of
2002.
. A $2.4 million non-cash impairment charge to write-down the value of
facilities in Vancouver, Washington. This charge represents the
difference between the expected proceeds from the sale of the
facilities, which include a building, improvements, land, and furniture
and fixtures, and the book value of these assets.
. $0.6 million in operating costs related to the Vancouver facility to be
sold. These costs represent the costs to operate and maintain the
facilities from the time they are vacated through the estimated sale
date of December 31, 2002.
. $0.6 million in contractual lease expenses primarily related to the cost
to terminate a facility lease in Houston, Texas.
. $0.6 million in other costs related to the restructuring activities.
The components of the restructure charge and the amounts paid and accrued
as of December 31, 2001 are as follows:
Total Paid in Accrued
Charge 2001 Non-Cash at 12/31/01
------ ------- -------- -----------
(amounts in thousands)
Employee severance....................... $2,670 1,138 -- 1,532
Facilities impairment.................... 2,359 -- 2,359 --
Facility operating costs................. 601 68 -- 533
Contractual lease commitments............ 628 -- -- 628
Other restructure expenses............... 580 142 -- 438
------ ----- ----- -----
$6,838 1,348 2,359 3,131
====== ===== ===== =====
EBITDA. EBITDA increased $45.9 million, to $177.5 million for 2001, from
$131.6 million for 2000. The increase was $82.1 million exclusive of the
effects of the GST asset acquisition. This improvement was primarily the
result of economies of scale generated in existing markets, including
increased utilization of networks and facilities, and the implementation of
cost reduction efforts. In addition, a $9.7 million increase in the
recognition of non-recurring reciprocal compensation from $27.3 million in
2000 to $37.0 million in 2001 contributed to the EBITDA improvement.
34
Depreciation and Amortization Expense. Depreciation and amortization
expense increased $112.3 million or 118%, to $207.6 million for 2001, from
$95.3 million for 2000. Exclusive of the effects of the GST asset acquisition,
this expense increased $50.2 million or 53%. The increase in depreciation and
amortization expense was primarily attributable to increased capital
expenditures and $9.6 million in impairment of certain non-revenue generating
assets.
Interest Expense. Interest expense increased $73.9 million to $115.1
million in 2001 compared to $41.2 million for 2000. The increase in interest
expense resulted from the January 2001 issuance of $400 million in 10 1/8%
Senior Notes and the draw down of $250 million on the Company's senior secured
credit facility in December 2000 and January 2001. Interest expense relating
to the 9 3/4% Senior Notes, the 10 1/8% Senior Notes, and the $250 million
outstanding under the credit facility was $101.4 million for 2001. Interest
expense relating to the 9 3/4% Senior Notes was $40.2 million for 2000.
Capitalized interest was $7.1 million and $4.1 million for 2001 and 2000,
respectively.
Net Loss. Net loss changed $82.4 million to a loss of $81.2 million for
2001, from earnings of $1.2 million for 2000. The change in loss is primarily
due to an increase in depreciation expense of $112.3 million, and an increase
in net interest expense of $73.9 million from additional debt incurred
primarily to fund the GST asset acquisition. These increases were partially
offset by an increase in the deferred tax benefit of $53.0 million and an
increase in EBITDA of $45.9 million.
Year Ended December 31, 2000 Compared to Year Ended December 31, 1999
Revenue. Revenue increased $218.5 million or 81%, to $487.3 million for
2000, from $268.8 million for 1999. This increase in revenue is primarily
attributable to increased customers, increased revenue from existing
customers, a broader array of products offered, and acquisitions. Revenue from
the provision of dedicated transport services increased $111.4 million or 73%,
to $264.0 million for 2000, from $152.5 million for 1999. Switched service
revenue increased $107.1 million or 92%, to $223.4 million for 2000, from
$116.3 million for 1999. Exclusive of the effects of acquisitions and the
effects of the recognition of $27.3 million and $7.6 million of non-recurring
reciprocal compensation in 2000 and 1999, respectively, dedicated transport
service and switched service revenue increased 69% and 70%, respectively. The
increase in revenue from dedicated transport services primarily reflects a 28%
increase in average dedicated transport customers and a broader array of
services offered in existing markets. The increase in switched service revenue
reflects a 70% increase in average switched service customers, increased
revenue from switched access services, reciprocal compensation, and a broader
array of services offered in existing markets. Reciprocal compensation, the
mutual charges by local carriers for recovery of costs associated with the
termination of traffic on each other's networks, represented 6% and 7% of
total revenue for 2000 and 1999, respectively, excluding the effects of the
recognition of $27.3 million and $7.6 million of non-recurring reciprocal
compensation in 2000 and 1999, respectively. At December 31, 2000, the Company
offered dedicated transport services and switched services in 24 metropolitan
areas. At December 31, 1999, the Company offered dedicated transport services
in 21 metropolitan areas and switched services in 20 metropolitan areas.
Operating Expenses. Operating expenses increased $67.4 million or 57%, to
$185.0 million for 2000, from $117.6 million for 1999. Exclusive of the
effects of acquisitions, these expenses increased 52%. The increase in
operating expenses was primarily attributable to the Company's expansion of
its business, principally switched services, the ongoing development of
existing markets resulting in higher LEC charges for circuit leases and
interconnection, and higher headcount for technical personnel. Excluding the
impact of non-recurring reciprocal compensation, as a percentage of revenue,
operating expenses decreased to 40% for 2000 from 45% for 1999.
Selling, General, and Administrative Expenses. Selling, general, and
administrative expenses increased $57.3 million or 51%, to $170.7 million for
2000, from $113.4 million for 1999. Exclusive of the effects of acquisitions,
these expenses increased 49%. The increase in selling, general, and
administrative expenses was primarily attributable to an increase in employee
headcount and higher direct sales costs associated with the increase in
revenue, higher property tax expense, and an increase in the provision for
doubtful accounts.
35
Excluding the impact of non-recurring reciprocal compensation, as a percentage
of revenue, selling, general, and administrative expenses decreased to 37% for
2000 from 43% for 1999.
EBITDA. EBITDA increased $93.8 million, to $131.6 million for 2000, from
$37.8 million for 1999. Exclusive of the effects of acquisitions and the
effects of the recognition of $27.3 million and $7.6 million of non-recurring
reciprocal compensation in 2000 and 1999, respectively, such amount increased
$74.1 million. This improvement was primarily the result of economies of
scale, as more revenue was generated in existing markets, increased
utilization of networks and facilities, and a more skilled and productive
workforce.
Depreciation and Amortization Expense. Depreciation and amortization
expense increased $26.5 million, or 39%, to $95.3 million for 2000, from $68.8
million for 1999. Exclusive of the effects of acquisitions, this expense
increased 7%. The increase in depreciation and amortization expense was
primarily attributable to increased capital expenditures and increased
goodwill generated from acquisitions.
Interest Expense. During the period July 1, 1997 through July 14, 1998, all
of the Company's financing requirements were funded with loans from Time
Warner Inc., Time Warner Entertainment Company, L.P., and Time Warner
Entertainment-Advance/Newhouse Partnership (the "Former Parent Companies").
These loans remained outstanding, accruing interest, through May 14, 1999. On
July 21, 1998, the Company issued $400 million in 9 3/4% Senior Notes in a
public offering. On May 14, 1999, the subordinated loans of approximately $180
million, including accrued interest, were repaid in full to the Former Parent
Companies from the IPO proceeds. Interest expense relating to the 9 3/4%
Senior Notes totaled $40.2 million for 2000 and interest expense relating to
the 9 3/4% Senior Notes and subordinated loans payable aggregated $45.3
million for 1999. The decrease of $5.1 million is primarily due to the lower
weighted average debt balance during 2000.
Net Income (Loss). Earnings changed $90.5 million to $1.2 million for 2000,
from a net loss of $89.3 million for 1999. The earnings change is primarily
due to the improvement in EBITDA and a decrease in income tax expense.
Liquidity and Capital Resources
Operations. Cash provided by operating activities was $197.2 million for
2001 compared to $165.3 million for 2000. This increase in cash provided by
operating activities principally resulted from an increase in EBITDA and
changes in certain working capital accounts.
The expenditures incurred by the Company to enter new markets, together
with initial operating expenses, will generally result in negative EBITDA and
operating losses from the new market until an adequate customer base and
revenue stream for the new market has been established. Accordingly, the
Company expects that the network constructed in each new market will generally
produce negative EBITDA from the new market for at least two years after
operations commence in that market. Additionally, the Company currently
expects the operations related to the assets purchased from GST to generate
negative EBITDA as a result of the Company's investment in additional sales
force for these networks and further build-out until an adequate customer base
and revenue stream for the networks have been established. Although overall
the Company expects to continue to have positive EBITDA in the future as it
reduces its expansion into new markets, expands its business in existing
markets, and completes the integration of the GST asset acquisition, there is
no assurance that the Company will sustain the current level of EBITDA or
sufficient positive EBITDA to meet its working capital requirements, comply
with its debt covenants, and service its indebtedness.
Investing. Cash used in investing activities was $1.1 billion for 2001
compared to $178.6 million for 2000. During 2001, the Company used its
proceeds from the issuance of common stock and a portion of the proceeds from
the issuance of debt to fund the GST asset acquisition, capital expenditures,
and net purchases of marketable securities. During 2000, proceeds from the
maturities of marketable securities and cash flow from operating activities
were primarily used to fund capital expenditures.
36
Capital expenditures were $425.5 million for 2001 compared to $320.7
million for 2000. Capital expenditures for 2001 include $98.4 million related
to the continued build-out of the 15 markets and long-haul network acquired
from GST. The Company expects its capital expenditures for 2002 to be less
than the $425.5 million it incurred for capital expenditures in 2001.
The Company has increased its operational efficiencies by pursuing a
disciplined approach to capital expenditures. The Company's capital
expenditure program requires that prior to making expenditures on a project,
the project must be evaluated to determine whether it meets stringent
financial criteria such as minimum recurring revenue, cash flow margins, and
rate of return. Until the economy improves, the Company expects that capital
expenditures will generally be limited to building entries, electronics, and
distribution rings based on specific revenue opportunities in existing markets
as well as upgrades to its back office systems. The Company's disciplined
spending approach allowed it to adjust spending appropriately as revenue
growth declined in 2001, thus maintaining strong margins.
The Company regularly evaluates potential acquisitions and joint ventures
that would extend its geographic markets, expand its services, or enlarge the
capacity of its networks. If the Company enters into a definitive agreement
with respect to any acquisition or joint venture, it may require additional
financing which could result in the Company increasing its leverage or issuing
additional common stock, or both. A substantial transaction may require the
consent of the Company's lenders. There can be no assurance, however, that the
Company will enter into any transaction or, if it does, on what terms. See
"Risk Factors--We may complete a significant business combination or other
transaction that could affect our leverage, result in a change in control, or
both" in Item 1 above.
While the Company intends to continue to leverage its relationship with AOL
Time Warner Inc. in pursuing expansion opportunities, to the extent the
Company seeks to expand into service areas where Time Warner Cable does not
conduct cable operations, the Company may incur costs in excess of those it
historically incurred when expanding into existing Time Warner Cable service
areas. In addition, Time Warner Cable is not obligated to construct or provide
additional fiber optic capacity in excess of what is already licensed to the
Company under the Capacity License Agreements. Accordingly, if the Company is
unable to lease additional capacity at the same rates as currently provided
for under certain operating agreements, the Company may be required to obtain
additional capacity on more expensive terms. The Company continually explores
other business opportunities with AOL Time Warner Inc. The Company is
currently evaluating an opportunity to provide certain network and support
services to AOL Time Warner Inc. in connection with its possible launch of
voice over Internet protocol services. To date, limited trials have been
completed and the Company has devoted limited resources to this opportunity.
Financing. Net cash provided by financing activities for 2001 was $1.0
billion and was primarily related to the net proceeds from both the issuance
of common stock and debt.
In order to fund the GST asset acquisition, the development of those
assets, and its other capital expenditure needs, in December 2000 the Company
replaced its $475 million senior secured revolving credit facility with a $1
billion amended and restated senior secured credit facility which provides for
$525 million of senior secured term loan facilities and a $475 million senior
secured revolving credit facility. In December 2000, the Company was required
to draw and hold in escrow $179 million of the credit facility until the
closing of the GST asset acquisition, at which time the draw increased to $250
million. The obligations under the senior secured credit facility are secured
by substantially all of the assets of the Company's subsidiaries, including
the assets acquired from GST. In addition, the Company has pledged its equity
interests in its subsidiaries as collateral.
Interest on the $250 million drawn under the credit facility is computed
utilizing a specified Eurodollar rate plus 4.0%, which totaled 6.1% on
December 31, 2001. Interest is payable at least quarterly. Based on the rate
in effect and the outstanding balance on December 31, 2001, aggregate annual
interest payments are expected to be approximately $15.3 million through 2008.
These anticipated payments will fluctuate with changes in amounts borrowed and
changes in the interest rate.
37
In January 2001, the Company issued $400 million principal amount of 10
1/8% Senior Notes due 2011 and 7,475,000 shares of Class A common stock in a
public offering at an offering price of $74 7/16 per share. The proceeds from
the issuance of Class A common stock and a portion of the proceeds from the
issuance of the 10 1/8% Senior Notes were used to repay a senior unsecured
bridge loan facility under which the Company borrowed $700 million to
initially finance the purchase of the GST assets and pay related fees and
expenses. In connection with the repayment of the senior unsecured bridge loan
facility, the Company recorded $5.8 million of deferred financing costs as a
non-recurring expense in the first quarter of 2001. In connection with the
issuance of Class A common stock, approximately $23.3 million of unamortized
deferred financing costs were recorded in additional paid-in capital in the
first quarter of 2001.
The $400 million principal amount in 9 3/4% Senior Notes that the Company
issued in July 1998 are unsecured, unsubordinated obligations of the Company.
Interest on the 9 3/4% Senior Notes is payable semiannually on January 15 and
July 15. Aggregate annual interest payments on the 9 3/4% Senior Notes are
expected to be approximately $39 million. The 9 3/4% Senior Notes are required
to be repaid on July 15, 2008.
The $400 million in principal amount of 10 1/8% Senior Notes that the
Company issued in the first quarter of 2001 are unsecured, unsubordinated
obligations of the Company. Interest on the 10 1/8% Senior Notes is payable
semiannually on February 1 and August 1. Aggregate annual interest payments on
the 10 1/8% Senior Notes are expected to be approximately $41 million. The 10
1/8% Senior Notes are required to be repaid on February 1, 2011.
The 9 3/4% Senior Notes and the 10 1/8% Senior Notes are governed by
indentures that contain certain restrictive covenants. These restrictions
affect, and in many respects significantly limit or prohibit, among other
things, the ability of the Company to incur indebtedness, make prepayments of
certain indebtedness, pay dividends, make investments, engage in transactions
with shareholders and affiliates, issue capital stock of subsidiaries, create
liens, sell assets, and engage in mergers and consolidations.
The Company is aware that its outstanding 9 3/4% and 10 1/8% Senior Notes
are currently trading at substantial discounts to their respective face
amounts. In order to reduce future cash interest payments, as well as future
amounts due at maturity or mandatory redemption, the Company or its affiliates
may, from time to time, purchase such securities for cash in open market or
privately negotiated transactions. Such a transaction would require the
consent of the lenders of the senior secured credit facility. The Company will
evaluate any such transactions in light of market conditions, taking into
account its liquidity and prospects for future access to capital.
38
The Company expects that the $384.1 million in cash, cash equivalents, and
marketable debt securities at December 31, 2001, and borrowings under the $1
billion credit facility, of which $750 million was undrawn as of December 31,
2001, along with internally generated funds, will provide sufficient funds for
the Company to meet its expected capital expenditures and liquidity needs to
operate its business as currently planned and to service its current and
future debt.
The Company's credit facility contains certain financial covenants,
including leverage and interest coverage ratios. These ratios are primarily
derived from EBITDA and debt levels, and are summarized in the table below.
Performance Requirements
---------------------------------
Ratio (1) Calculation (2) Period (3) Ratio
--------- -------------------------------------------------------- -------------------- ------------
Senior Leverage Ratio Consolidated total debt less senior 01/01/02--06/30/02 4.00 to 1.0
notes and cash in excess of $50 million, 07/01/02--12/31/02 3.50 to 1.0
divided by annualized EBITDA for the most recent quarter 01/01/03--thereafter 3.00 to 1.0
Consolidated Leverage
Ratio Consolidated total debt less cash in 01/01/02--03/31/02 10.00 to 1.0
excess of $50 million, divided by 04/01/02--06/30/02 8.00 to 1.0
annualized EBITDA for the most recent 07/01/02--09/30/02 7.00 to 1.0
quarter 10/01/02--12/31/02 6.00 to 1.0
01/01/03--03/31/03 5.50 to 1.0
04/01/03--thereafter 5.00 to 1.0
Consolidated Interest
Coverage Ratio Consolidated EBITDA for the most 07/01/02--09/30/02 1.00 to 1.0
recent four quarters divided by 10/01/02--12/31/02 1.25 to 1.0
consolidated interest expense for the 01/01/03--06/30/03 1.50 to 1.0
most recent four quarters 07/01/03--thereafter 2.00 to 1.0
Consolidated Debt Consolidated EBITDA for the most Commencing 12/31/04 1.50 to 1.0
Service Coverage Ratio recent four quarters divided by the sum
of consolidated interest expense for the
most recent four quarters plus
scheduled principal payments on debt
for the following four quarters.
- --------
(1) As defined in the credit agreement. The credit agreement has been
incorporated herein by reference as Exhibit 10.16.
(2) The descriptions of the calculations provide general information regarding
the referenced ratio. Other factors, as defined in the credit agreement,
may impact the actual calculation.
(3) As measured on the last day of a fiscal quarter.
A lack of revenue growth or an inability to control costs could negatively
impact EBITDA performance and cause the Company to fail to meet the required
minimum ratios. Although the Company currently believes that it will continue
to be in compliance with its covenants, factors outside the Company's control
including further deterioration of the economy, an acceleration of customer
disconnects, or a significant reduction in demand for the Company's services
without adequate reductions in capital expenditures and operating expenses
could cause the Company to fail to meet its covenants. If the Company's
revenue growth is not sufficient to sustain the EBITDA performance required to
meet the debt covenants described above without adequate reductions in capital
expenditures, the Company would have to consider cost-cutting measures to
maintain required EBITDA levels or to enhance liquidity. These measures could
include reductions in certain discretionary expenditures such as training,
travel, and employee benefits, reductions in headcount, or shutting down less
profitable operations.
The senior secured credit facility also limits the ability of the Company
to declare dividends, incur indebtedness, incur liens on property, and make
capital expenditures. In addition, the senior secured facility includes cross
default provisions under which the Company is deemed to be in default under
that facility if it defaults under any of the other material outstanding
obligations, such as the 9 3/4% Senior Notes or the 10 1/8% Senior Notes.
Failure to meet these covenants would preclude the Company from drawing funds
under the credit facility unless the lenders agree to modify the covenants and
could potentially cause an acceleration of the repayment schedule. Although
the Company believes its relationships with its lenders are good, there is no
39
assurance that the Company would be able to obtain the necessary modifications
on acceptable terms. In the event that the Company's plans or assumptions
change or prove to be inaccurate, or the foregoing sources of funds prove to
be insufficient to fund the Company's growth and operations, or if the Company
consummates acquisitions or joint ventures, the Company would be required to
seek additional capital. The Company's revenue and costs are partially
dependent upon factors that are outside the Company's control, such as
regulatory changes, changes in technology, and increased competition. Due to
the uncertainty of these and other factors, actual revenue and costs may vary
from expected amounts, possibly to a material degree, and these variations
would likely affect the level of the Company's future capital expenditures and
expansion plans. Any additional sources of financing may include public or
private debt, equity financing by the Company or its subsidiaries, or other
financing arrangements.
Commitments. The following table summarizes the Company's long-term
commitments as of December 31, 2001, including commitments pursuant to debt
agreements, lease obligations, and fixed maintenance contracts.
Contractual obligations Total 2002 2003 2004 2005 2006 Thereafter
----------------------- ---------- ------ ------ ------ ------ ------ ----------
(amounts in thousands)
Principal payments on
long-term debt......... $1,050,000 0 2,500 2,500 2,500 2,500 1,040,000
Capital lease
obligations including
interest(1)............ 29,307 6,031 4,009 3,192 2,552 2,301 11,222
Operating lease
obligations............ 200,871 27,078 25,389 22,706 19,390 16,491 89,817
Fixed maintenance
obligations............ 71,354 4,101 4,101 4,101 3,005 3,005 53,041
---------- ------ ------ ------ ------ ------ ---------
Total................. $1,351,532 37,210 35,999 32,499 27,447 24,297 1,194,080
========== ====== ====== ====== ====== ====== =========
- --------
(1) Includes amounts representing interest of $11.9 million.
Effects of Inflation
Historically, inflation has not had a material effect on the Company.
Recent Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board issued Statement No.
133, Accounting for Derivative Instruments and Hedging Activities ("SFAS
133"), as amended by SFAS 138, which was adopted by the Company on January 1,
2001. SFAS 133 requires that all derivatives be recorded on the balance sheet
at fair value. Changes in derivatives that are not hedges are adjusted to fair
value through income. Changes in derivatives that meet SFAS 133's hedge
criteria are either offset through income or recognized in other comprehensive
income until the hedged item is recognized in earnings. The adoption of SFAS
133 on January 1, 2001 did not have a material effect on the Company's
financial condition, results of operations, or cash flows because the Company
does not own derivative instruments.
In July 2001, the Financial Accounting Standards Board issued Statement No.
141, Business Combinations ("SFAS 141") and Statement No. 142, Goodwill and
Other Intangible Assets ("SFAS 142"). SFAS 141 requires companies to reflect
intangible assets apart from goodwill and supersedes previous guidance related
to business combinations. SFAS 142 eliminates amortization of goodwill and
amortization of all intangible assets with indefinite useful lives. However,
SFAS 142 also requires the Company to perform impairment tests at least
annually on all goodwill and indefinite-lived intangible assets. These
statements are required to be adopted by the Company on January 1, 2002 and
for any acquisitions entered into after July 1, 2001. The Company does not
believe the adoption of the statements will negatively impact its financial
position, results of operations, and cash flows. Goodwill amortization expense
aggregated $2.8 million, $3.2 million, and $2.0 million in 2001, 2000, and
1999, respectively.
In August 2001, the Financial Accounting Standards Board issued Statement
No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets ("SFAS
144"). SFAS 144 addresses financial accounting and
40
reporting for the impairment or disposal of long-lived assets and supercedes
SFAS 121, Accounting for the Impairment of Long-Lived Assets and for Long-
Lived Assets to be Disposed Of, and the accounting and reporting provisions of
Accounting Principles Board Opinion No. 30, Reporting the Results of Operation
for a disposal of a segment of a business. SFAS 144 is required to be adopted
by the Company on January 1, 2002 and the Company does not believe the
adoption of the standard will have a significant impact on its financial
position, results of operations, or cash flows.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
The Company's interest income is sensitive to changes in the general level
of interest rates. In this regard, changes in interest rates can affect the
interest earned on the Company's cash equivalents and marketable debt
securities. To mitigate the impact of fluctuations in interest rates, the
Company generally enters into fixed rate investing arrangements.
The following table provides information at December 31, 2001 about the
Company's investments that are sensitive to changes in interest rates. For
these securities, the table presents related weighted-average interest rates
expected by the maturity dates. These investment securities will mature within
one year.
2002 Maturities
---------------
(dollar amounts
in thousands)
Assets
Marketable debt securities:
Shares of money market mutual funds........................ $ 93,323
Weighted average interest rate............................. 2.2%
Corporate and municipal debt securities...................... $286,674
Weighted average interest rate............................. 1.9%
At December 31, 2001, the fair value of the Company's fixed rate 9 3/4%
Senior Notes due 2008 and the Company's fixed rate 10 1/8% Senior Notes due
2011 was $314 million and $318 million, respectively, as compared to a
carrying value of $400 million each on the same date, based on market prices.
Interest on amounts drawn under the $1 billion credit facility varies based
on a specific Eurodollar rate. Based on the $250 million outstanding balance
as of December 31, 2001, a one-percent change in the applicable rate would
change the amount of interest paid by $2.5 million for 2002.
Item 8. Financial Statements and Supplementary Data
See "Index to Consolidated Financial Statements" at page F-1.
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
None.
41
PART III
Item 10. Directors of the Registrant(1)
Director
Name and Age Since Principal Occupation and Other Information
------------ ------------ ----------------------------------------------------
Larissa L. Herda (43) July 1998 Chairman of the Company since June 2001. President
and Chief Executive Officer of the Company since
June 1998.
Senior Vice President Sales of the Company from
March 1997 to June 1998.
1989-1997 employed by MFS Telecom, Inc., a
competitive local exchange carrier, most recently as
Southeast Regional Vice President and General
Manager.
Director of Agilera, an application service provider
which is a joint venture between Ciber, Inc., Verio,
Inc., and Centennial Ventures, since November 2000.
- -----------------------------------------------------------------------------------------
Glenn A. Britt (53) July 1998 Chairman and Chief Executive Officer of Time Warner
Cable since August 2001; President of Time Warner
Cable since January 1999.
Vice President of the Company and non-executive
Chairman of the Board of Directors from July 1998 to
June 2001.
Chief Executive Officer and President of Time Warner
Cable Ventures, a division of Time Warner Cable,
from January 1999.
- -----------------------------------------------------------------------------------------
Bruce L. Claflin (50) August 1999 President and Chief Executive Officer of 3Com
Corporation since January 2001. President and Chief
Operating Officer of 3Com Corporation, September
1998 to December 2000.
Senior Vice President and General Manager, Sales and
Marketing at Digital Equipment Corporation from July
1997 to June 1998.
Vice President and General Manager--Personal
Computer Business Unit at Digital Equipment
Corporation from October 1995 to June 1997.
Senior management and executive positions at
International Business Machines Corporation from
April 1973 to October 1995.
- -----------------------------------------------------------------------------------------
Richard J. Davies (54) October 1998 Senior Vice President, Corporate Development of Time
Warner Cable since January 1999.
Senior Vice President of Time Warner Cable Ventures
from June 1996 to December 1998.
Chief Financial Officer of the Company from March
1993 to June 1996.
- -----------------------------------------------------------------------------------------
Spencer B. Hays (57) October 1999 Senior Vice President and Deputy General Counsel of
AOL Time Warner Inc. since its formation on January
11, 2001. Prior to that time, Vice President and
Deputy General Counsel of Time Warner Inc., since
its formation in 1990.
Prior to 1990 employed in various capacities by Time
Warner Inc.'s predecessor, Warner Communications
Inc., most recently as Senior Vice President and
General Counsel.
- -----------------------------------------------------------------------------------------
42
Director
Name and Age Since Principal Occupation and Other Information
------------ ------------- ----------------------------------------------------
Lisa A. Hook (44) August 1999(2) President of AOL Anywhere since August 2001.
Senior Vice President and Chief Operating Officer of
AOL Mobile from October 2000 to July 2001. Senior
Vice President of AOL Mobile from April 2000 to
September 2000.
Director and major shareholder representative of
Classic Communications, a cable television operator,
from 1999 until 2000.
Principal of Brera Capital Partners, a private
equity firm, from 1998 to 2000.
Director of Roberts Radio, a small market radio
consolidator, from 1997 to 2000.
Principal of Alpine Capital, a private equity firm,
from 1996 to 1998.
- ---------------------------------------------------------------------------------------------
Robert J. Miron (64) July 1998 President of Advance/Newhouse Communications since
April 1995.
President of Newhouse Broadcasting Corporation from
October 1986 to April 1995.
- ---------------------------------------------------------------------------------------------
Theodore H. Schell (57) February 2001 General Partner, APAX Partners, Inc., an investment
company, since 2000.
Senior Vice President, Strategy and Corporate
Development, Sprint Corporation from July 1999 to
June 2001.
President and CEO of Realcom Communications
Corporation from June 1983 to June 1988.
Director of Upoc, Inc., a mobile wireless network
company, since January 2001.
Director of Webraska, Mobile Technologies, France, a
provider of location-based services, since January
2001.
Director of Webley Systems, Inc., an integrated
messaging company, since 2001.
Director of FLAG Telecom, a global communications
company, since April 2001.
Director of Hybrid Networks, Inc., a provider of
telecom equipment from 1998 to 2000.
Director of Kansas City Board of Trade, a commodity
exchange, from 1998 to 2000.
- --------
(1) Independent director, William S. Schleyer resigned from the Board of
Directors effective November 30, 2001. The Nominating Committee of the
Board of Directors is interviewing candidates and expects to have a
nominee to fill the vacancy prior to the mailing of the Company's proxy
statement for the 2002 Annual Meeting of Stockholders.
(2) Lisa Hook resigned as an independent director on January 11, 2001 and was
re-elected to the Board of Directors February 7, 2001 as an AOL Time
Warner Inc. nominee.
43
Executive Officers
The following table sets forth information concerning the individuals who
serve as our executive officers, with the exception of Larissa Herda, who
serves as Chairman, President, and Chief Executive Officer and whose
information is located above under "Directors".
Name and Age Principal Occupation and Other Information
------------ -------------------------------------------------------------------
David J. Rayner (44) Senior Vice President and Chief Financial Officer of the Company
since June 1998.
Vice President, Finance of the Company from February 1997 to May
1998.
Controller of the Company from May 1994 to February 1997.
Financial and operational management positions at Time Warner Cable
from 1982 to 1994.
- --------------------------------------------------------------------------------------------
Paul B. Jones (55) Senior Vice President, General Counsel, and Regulatory Policy of
the Company since August 1998.
Senior Vice President, Legal and Regulatory Policy of the Company
from October 1993 to August 1998.
Senior Vice President, Corporate Development of Time Warner Cable
Ventures from 1992-1993.
Senior Vice President and General Counsel of Warner Cable from 1986
to 1992.
Vice President, Strategy and Development of CBS Publishing Group
from 1984 to 1986.
Assistant General Counsel for the FCC from 1977 to 1979.
- --------------------------------------------------------------------------------------------
John T. Blount (43) Executive Vice President, Field Operations of the Company since
October 2000.
Senior Vice President Sales of the Company from June 1998 to
October 2000.
Regional Vice President for the Midwest and Southwest Regions of
the Company from January 1997 to June 1998.
Vice President and General Manager/Milwaukee of the Company from
January 1996 to January 1997.
General Manager/Milwaukee of the Company from February 1995 to
January 1996.
Employed by U S WEST !nterprise from 1988 to February 1995.
- --------------------------------------------------------------------------------------------
Michael A. Rouleau (43) Senior Vice President, Marketing and Business Development of the
Company since November 1999.
Vice President, Marketing and Product Development of Transport
Service of U S WEST, Inc. from July 1997 to November 1999.
Executive Director, Marketing and Product Development of U S WEST,
Inc. from April 1995 to June 1997.
- --------------------------------------------------------------------------------------------
44
Name and Age Principal Occupation and Other Information
------------ -------------------------------------------------------------------
A. Graham Powers (55) Senior Vice President, Implementation of the Company since April
1998.
Senior Vice President, Engineering and Technology of the Company
from June 1996 to March 1998.
Senior Vice President, Operations Development and Business
Implementation of the Company from August 1993 to May 1996.
President of Telecommunications Strategy, Inc., a technology
consulting service, from May 1992 to July 1993.
- -------------------------------------------------------------------------------------------
Julie A. Rich (48) Senior Vice President, Human Resources and Business Administration
of the Company since April 1999.
Vice President, Human Resources and Business Administration of the
Company from March 1998 to April 1999.
Owner of an independent human resources consulting practice from
June 1996 to February 1998.
Founder of XEL Communications, Inc., a telecommunications
manufacturer, holding positions of Director and Vice President of
Human Resources from 1984 to 1996.
- -------------------------------------------------------------------------------------------
Mark D. Hernandez (42) Senior Vice President and Chief Information Officer of the Company
from June 2001.
Vice President, Information Technology of the Company from January
2001 to June 2001.
Vice President of Billing and Revenue Assurance of the Company from
February, 2000 to January 2001.
Vice President of US West Long Distance from June 1996 to February
2000.
- -------------------------------------------------------------------------------------------
Section 16(a) Beneficial Ownership Reporting Compliance
Based on a review of reports filed by our directors, executive officers and
beneficial holders of 10% or more of our shares, and upon representations from
those persons, all Securities and Exchange Commission stock ownership reports
required to be filed by those reporting persons during 2001 were made timely
except that Ms. Patricia Gorman, former Executive Vice President, Corporate
Operations inadvertently filed her Form 4 reporting the sale of 130 shares of
common stock for September 2001 late.
45
Item 11. Executive Compensation
Summary of Compensation
The following table summarizes the compensation the Company paid during the
last three years to the President and Chief Executive Officer and to each of
the four other most highly compensated executive officers as of the end of
2001 and to the Company's former Executive Vice President, Corporate
Operations, based on salary and bonus.
Long-Term Compensation Awards
----------------------------------
Time Warner
Telecom
Class A
Common Stock
Annual Compensation Restricted Underlying All Other
---------------------- Stock Options LTIP Compensation
Name & Principal Position Year Salary Bonus Awards(1) Awarded(2) Payouts(3) (4)
- ------------------------- ---- -------- -------- ---------- ------------ ---------- ------------
Larissa L. Herda, 2001 $400,007 $379,997 $1,619,200 440,000 $ -- $8,500
Chairman, President, and 2000 312,025 327,613 -- 70,000 -- 8,500
Chief Executive Officer 1999 312,025 234,009 -- 1,000,000 -- 8,000
Paul B. Jones, 2001 268,502 127,536 294,400 90,000 -- 8,500
Senior Vice President,
General 2000 259,242 179,849 -- 25,000 -- 8,500
Counsel & Regulatory
Policy(5) 1999 259,242 184,710 -- 100,000 96,900 8,000
David J. Rayner, 2001 220,000 156,750 441,600 120,000 -- 8,500
Senior Vice President
and 2000 209,615 220,371 -- 40,000 -- 8,500
Chief Financial
Officer(5) 1999 182,970 132,653 -- 300,000 -- 8,000
John T. Blount, 2001 220,000 156,750 441,600 120,000 -- 8,500
Executive Vice
President, 2000 197,442 166,607 -- 40,000 -- 8,500
Field Operations(6) 1999 180,730 128,770 -- 300,000 -- 8,000
A. Graham Powers, 2001 192,400 91,390 220,800 75,000 -- 8,500
Senior Vice President, 2000 185,000 126,031 -- 25,000 -- 8,500
Implementation 1999 182,500 132,311 -- 100,000 43,605 8,000
Patricia E. Gorman, 2001 220,000 140,250 220,800 75,000 -- 8,500
Former Executive Vice
President, 2000 62,023 81,694 -- -- -- 2,539
Corporate Operations(7)
- --------
(1) The valuation of restricted stock awards is based on the $14.72 closing
price of the Company's Class A common stock as of the November 16, 2001
grant date. As of December 31, 2001, Ms. Herda held 110,000 restricted
shares valued at $1,945,900 (based on the December 31, 2001 closing price
of $17.69); Mr. Jones held 20,000 restricted shares valued at $353,800;
Messrs. Rayner and Blount each held 30,000 restricted shares valued at
$530,700; and Mr. Powers and Ms. Gorman each held 15,000 restricted shares
valued at $265,350. The restricted shares vest as follows: 50% in November
2003, 25% in November 2004, and 25% in November 2005, except that under
the terms of an agreement with Ms. Gorman, her restricted shares will vest
only until November 2003 to the extent of 7,500 shares, provided that she
complies with the terms of the agreement.
(2) Options awarded under the Company's 1998 and 2000 Option Plans.
(3) These payouts were made in 1999 to participants in the Time Warner Cable
Long-Term Cash-Flow Incentive Plan for the 1995-1998 four-year cycle.
(4) Includes contributions made by the Company to the Company's defined
contribution 401(k) plan on behalf of the named executive officers.
(5) The Company does not currently have its own pension plan. However, Messrs.
Jones and Rayner will, upon retirement, be entitled to receive benefits
under the Time Warner Cable Pension Plan based on service to the Company
or Time Warner Cable on or prior to December 31, 1998.
(6) As a result of his previous employment with U S WEST, Inc., the
predecessor of MediaOne Group, Inc., Mr. Blount and certain other former
employees of U S WEST, Inc. participated in a pension plan under the
administration of MediaOne Group, Inc. Mr. Blount's and other Company
employees' participation in that plan was terminated in 2000 following the
merger of AT&T Corp. and MediaOne Group, Inc. Mr. Blount's benefits under
that plan upon his retirement are based on service to U S WEST, Inc. or
the Company.
(7) Ms. Gorman left the Company effective March 18, 2002.
46
Employment Agreements
The Company has entered into employment agreements with the current
executive officers shown in the compensation table with terms beginning
January 1, 2000:
. Ms. Herda's contract has a five-year term;
. Messrs. Blount and Rayner's contracts have four-year terms; and
. Messrs. Jones and Powers' contracts have three-year terms.
The minimum annual salaries for Ms. Herda and Messrs. Jones, Rayner,
Blount, and Powers for the year 2001 under these agreements are their actual
salaries for 2001.
The agreements include a narrow definition of the term "cause." If the
contract is terminated for cause, the executive will only receive earned and
unpaid base salary accrued through such date of termination. These agreements
provide that if the Company materially breaches or terminates the executive's
employment during the term without cause, the executive may elect either:
. to receive a lump-sum payment of the present value of the base salary
and annual bonus otherwise payable during the remaining term of
employment, but not less than the sum of the salary and bonus prorated
for an 18-month period; or
. to remain an employee of the Company for up to 18 months and, without
performing any services, receive the base salary and annual bonus
otherwise payable.
The executives have the same two options if a change of control occurs and
that change results in:
. a change of more than 50 miles in the location of the executive's office
or the Company's principal executive offices;
. a material reduction in the executive's responsibilities; or
. the Company's material breach of the agreement.
The agreements define change of control to mean that:
. the Class B Stockholders cease to have the ability as a group to elect a
majority of the Company's Board of Directors;
. another person or group has become the beneficial owner of more than 35%
of the total voting power of the Company's voting interests; or
. the percentage voting interest of that person or group is greater than
that held by the Class B Stockholders.
Executives are not generally required to mitigate damages after such a
termination, except as necessary to prevent the Company from losing any tax
deductions that it otherwise would have been entitled to for any payments
deemed to be "contingent on a change" under the Internal Revenue Code.
If an executive becomes disabled during the term of his or her employment
agreement, the executive typically will receive 75% of the executive's then
current salary and his or her applicable target annual bonus amount prorated
for an 18-month period. These payments will be reduced by amounts received
from Worker's Compensation, Social Security, and disability insurance policies
maintained by the Company.
If an executive dies during the term of an employment agreement, generally
the executive's beneficiaries will receive the executive's earned and unpaid
salary up to thirty days after the date of death and a pro rata portion of the
executive's bonus for the year of death.
47
Stock Options Awarded by the Company During 2001
The following table lists the Company's grants during 2001 of stock options
to the officers named in the Summary of Compensation Table. All of the options
were nonqualified under the Internal Revenue Code and the Company did not
award any stock appreciation rights. The amounts shown as potential realizable
values rely on arbitrarily assumed increases in value required by the
Securities and Exchange Commission. In assessing those amounts, please note
that the ultimate value of the options depends on actual future share prices.
Market conditions and the efforts of the directors, the officers, and others
to foster the future success of the Company can influence those future share
values.
Option Grants in the Last Fiscal Year
Individual Grants
Potential Realizable
% of Total Value at Assumed
Number of Options Annual Rates of Stock
Securities Granted to Exercise Price Appreciation for
Underlying Employees or Base Option Term(1)
Options in 2001 Price Expiration ----------------------
Name Granted (#) Fiscal Year ($/share) Date 5% 10%
---- ----------- ----------- --------- ---------- ---------- -----------
Larissa L. Herda........ 440,000 7.78% $14.72 11/15/2011 $4,071,815 $10,317,965
Paul B. Jones........... 90,000 1.59% 14.72 11/15/2011 832,871 2,110,493
David J. Rayner......... 120,000 2.12% 14.72 11/15/2011 1,110,495 2,813,990
John T. Blount.......... 120,000 2.12% 14.72 11/15/2011 1,110,495 2,813,990
A. Graham Powers........ 75,000 1.33% 14.72 11/15/2011 694,059 1,758,744
Patricia E. Gorman (2).. 75,000 1.33% 14.72 11/15/2001 694,059 1,758,744
- --------
Total shares granted to all employees in 2001: 5,670,525
(1) The options shown in the above table were awarded to the named executive
officers under the Company's 2000 Employee Stock Plan and the terms are
governed by that plan and the recipient's option agreement. The exercise
price is the fair market value of the Class A common stock on the date of
grant. The options become exercisable over a four-year vesting period and
expire ten years from the date of grant, except as noted below with
regards to Ms. Gorman's options. As required by Securities and Exchange
Commission rules, the dollar amounts in the last two columns represent the
hypothetical gain or "option spread" that would exist for the options
based on assumed 5% and 10% annual compounded rates of Class A common
stock appreciation over the full ten-year option term (resulting in 63%
and 159% appreciation, respectively). These assumed rates of appreciation
applied to the exercise price would result in a Class A common stock value
on November 15, 2011 of $23.98 and $38.18, respectively. These prescribed
rates are not intended to forecast possible future appreciation, if any,
of the Class A common stock.
(2) The data presented for Ms. Gorman, former Executive Vice President,
Corporate Operations, is as of December 31, 2001. Subsequent to that time,
the Company and Ms. Gorman entered into an agreement pursuant to which all
options granted to Ms. Gorman cease to vest on July 1, 2003 and any
unexercised options expire October 1, 2003.
48
Option Exercises and Values in 2001
Three of the named executive officers listed under the heading "Option
Grants in the Last Fiscal Year" exercised options in 2001. The table below
shows the number and value of their exercisable and non-exercisable options as
of December 31, 2001.
Aggregated Option Exercises in Last Fiscal Year and Fiscal Year-End Option
Values
Number of Securities
Underlying Unexercised Value of Unexercised
Value Options at Fiscal Year- In-the-Money Options
Shares Realized End at Fiscal Year-End
Acquired on ------------------------- -------------------------
Name on Exercise Exercise Exercisable Unexercisable Exercisable Unexercisable
---- ----------- ---------- ----------- ------------- ----------- -------------
Larissa L. Herda........ 65,000 $3,293,865 430,625 1,289,375 $928,181 $1,573,519
Paul B. Jones........... -- -- 176,500 204,500 826,473 385,368
David J. Rayner......... 20,000 1,190,000 119,375 390,625 195,594 445,306
John T. Blount.......... 16,000 954,938 136,500 387,500 293,035 427,525
A. Graham Powers........ -- -- 118,750 181,250 497,875 293,875
Patricia E. Gorman...... -- -- 62,500 212,500 -- 222,750
- --------
The in-the-money value of unexercised options is equal to the excess of the
per share market price of the Company's Class A common stock at December 31,
2001 ($17.69) over the per share exercise price, multiplied by the number of
unexercised options.
Aggregated Options to Purchase Common Stock of AOL Time Warner Inc.
and Fiscal Year-End Option Values
Three of the named executive officers hold options to purchase AOL Time
Warner Inc. common stock. The following table lists each of such officer's
information with respect to the status of their AOL Time Warner Inc. options
on December 31, 2001, including the total number of shares of AOL Time Warner
Inc. common stock underlying exercisable and nonexercisable stock options held
on December 31, 2001, and the aggregate dollar value of in-the-money
exercisable and nonexercisable stock options on December 31, 2001. None of the
named executive officers has been awarded stock appreciation rights alone or
in tandem with options. In addition, none of the named executive officers
exercised options to purchase common stock of AOL Time Warner Inc. during
2001.
Number of Shares Dollar Value of
Underlying Unexercised Unexercised In-the-Money
Options on Options on December 31,
December 31, 2001 2001*
------------------------- -------------------------
Name Exercisable Unexercisable Exercisable Unexercisable
---- ----------- ------------- ----------- -------------
Larissa L. Herda......... 26,400 -- $355,812 $--
David J. Rayner.......... 8,598 -- 78,962 --
A. Graham Powers......... 51,900 -- 827,422 --
- --------
* Based on a closing price of $32.10 per share of AOL Time Warner Inc. common
stock.
Option Terms
The option exercise price of all options held by the named executive
officers is the fair market value of the stock on the date of grant. All of
the options held by the named executive officers become immediately
exercisable in full upon the occurrence of certain events, including the death
or total disability of the option holder, certain change-of-control
transactions and, in most cases, the Company's breach of the holder's
employment agreement. The AOL Time Warner Inc. options held by the named
executive officers generally remain exercisable for three years after their
employment with the Company is terminated without cause, for one year after
death or total disability, for five years after retirement and for three
months after termination for any
49
other reason, except that such stock options awarded before 1996 are
exercisable for three months after a termination without cause and after
retirement, and those awarded after July 1997 are exercisable for three years
after death or disability. All AOL Time Warner Inc. options terminate
immediately if the holder's employment is terminated for cause. The terms of
the options shown in the chart are ten years.
Compensation Committee Interlocks and Insider Participation
In 2001, the members of the Company's Compensation Committee were
independent directors Theodore Schell, William Schleyer, and Bruce Claflin.
The Company's Human Resources and Benefits Committee makes recommendations
with respect to matters involving executive compensation. Its members in 2001
were Messrs. Britt, Claflin, Miron, and Schell. Mr. Britt is an officer of an
affiliate of AOL Time Warner Inc., and is a member of the Human Resources and
Benefits Committee. Certain relationships and transactions between the Company
and AOL Time Warner Inc. are described below under "Certain Relationships and
Related Transactions."
Item 12. Security Ownership of Certain Beneficial Owners and Management
Time Warner Telecom Share Ownership
The following table lists the Company's share ownership for its directors,
the executive officers named in the compensation table, all directors and
executive officers as a group, and persons known to the Company as beneficial
owners of more than 5% of the Company's Class A or Class B common stock as of
February 28, 2002, except as noted in the footnotes to the table. To the
Company's knowledge, each person, along with his or her spouse, has sole
voting and investment power over the shares unless otherwise noted.
Information in the table is as of the latest reports by those entities
received by the Company. Ownership includes direct and indirect (beneficial)
ownership, as defined by Securities and Exchange Commission rules. This table
assumes a base of 48,799,191 shares of Class A common stock and 65,936,658
shares of Class B common stock outstanding as of February 28, 2002, before any
consideration is given to other outstanding options, warrants, or convertible
securities. Each executive officer's address is c/o the Company, 10475 Park
Meadows Drive, Littleton, Colorado 80124.
Class A Common Class B Common
Stock (1)(2) Stock (1)(2)(3) Total Common Stock
------------------ ------------------- ---------------------------
% of
No. of Percent No. of Percent No. of Percent Voting
Name of Beneficial Owner Shares of Class Shares of Class Shares of Equity Power
- ------------------------ --------- -------- ---------- -------- ---------- --------- ------
Five Percent
Stockholders:
AOL Time Warner Inc.
(4).................... -- -- 50,363,739 76.4% 50,363,739 43.9% 71.1%
Newhouse Telecom
Holdings Corp. (5)..... -- -- 9,536,856 14.5% 9,536,856 8.3% 13.5%
Advance Telecom Holdings
Corp. (5).............. -- -- 6,036,063 9.1% 6,036,063 5.3% 8.5%
INVESCO Funds Group,
Inc. (6)............... 7,595,480 15.6% -- -- 7,595,480 6.6% 1.1%
Putnam Investments, LLC
(7).................... 7,580,887 15.5% -- -- 7,580,887 6.6% 1.1%
AT&T Corp. (8).......... 6,289,842 12.9% -- -- 6,289,842 5.5% 0.9%
Massachuesetts Financial
Services Company (9)... 3,866,814 7.9% -- -- 3,866,814 3.4% 0.5%
FMR Corp. (10).......... 3,325,500 6.8% -- -- 3,325,500 2.9% 0.5%
Chilton Investment
Company (11)........... 3,073,633 6.3% -- -- 3,073,633 2.7% 0.4%
Directors and Executive
Officers:
Larissa L. Herda........ 584,338 1.2% ---- ---- 584,338 * *
Glenn A. Britt.......... -- * ---- ---- ---- * *
Bruce L. Claflin........ 9,499 * ---- ---- 9,499 * *
Richard J. Davies....... -- * ---- ---- ---- * *
Spencer B. Hays......... -- * ---- ---- ---- * *
William T. Schleyer..... 3,883 * ---- ---- 3,883 * *
Robert J. Miron......... 7,500 * ---- ---- 7,500 * *
David J. Rayner......... 159,687 * ---- ---- 159,687 * *
Paul B. Jones........... 216,479 * ---- ---- 216,479 * *
John T. Blount.......... 175,250 * ---- ---- 175,250 * *
A. Graham Powers........ 143,317 * ---- ---- 143,317 * *
Patricia E. Gorman...... 90,236 * ---- ---- 90,236 * *
Theodore H. Schell...... 6,292 * ---- ---- 6,292 * *
Lisa A. Hook............ 1,799 * ---- ---- 1,799 * *
All directors and
executive officers as a
group (17 persons)..... 1,642,529 3.3% ---- ---- 1,642,529 * *
- --------
* Represents less than one percent.
50
(1) The Company has two classes of outstanding common stock, Class A common
stock and Class B common stock. Beneficial ownership of common stock has
been determined in accordance with the rules of the Securities and
Exchange Commission, which is based upon having or sharing the power to
vote or dispose of shares and includes: i) shares of Class A common stock
issuable upon exercise of options exercisable within 60 days of February
28, 2002, as follows: Ms. Herda--458,437 shares; Mr. Rayner--129,687
shares; Mr. Jones--188,437 shares; Mr. Blount--145,250 shares; Mr.
Powers--126,562 shares; Ms. Gorman--75,000 shares; and all directors and
executive officers as a group--1,340,217 shares and ii) shares of
restricted stock as follows: Ms. Herda--110,000 shares; Mr. Rayner--
30,000 shares; Mr. Jones--20,000 shares; Mr. Blount--30,000 shares; Mr.
Powers--15,000 shares; Ms. Gorman--15,000 shares; and all directors and
executive officers as a group--265,000 shares.
(2) Excludes an equal amount of Class A common stock into which Class B
common stock are convertible. The Class B common stock held by AOL Time
Warner Inc. subsidiaries (see note (4)), Newhouse Telecom Holdings
Corporation, and Advance Telecom Holdings Corporation, represented on a
converted basis 43.9%, 8.3%, and 5.3%, respectively, of the Class A
common stock.
(3) Solely as a result of the agreement of the Class B Stockholders to vote
in favor of the others' director nominees under the Stockholders'
Agreement, the Class B Stockholders may be deemed to share beneficial
ownership of the shares beneficially owned by each of them. See "Certain
Relationships and Related Transactions--Stockholders' Agreement."
(4) Owned by Time Warner Companies, Inc., American Television and
Communications Corporation, Warner Communications Inc., TW/TAE, Inc.,
FibrCOM Holdings, L.P., and Paragon Communications, each a direct or
indirect wholly owned subsidiary of AOL Time Warner Inc. The business
address of AOL Time Warner Inc. is 75 Rockefeller Plaza, New York, New
York 10019.
(5) The business address of Advance Telecom Holdings Corporation and Newhouse
Telecom Holdings Corporation is 6005 Fair Lakes Road, East Syracuse, New
York 13057.
(6) Based on a Schedule 13G dated January 31, 2002. The business address of
INVESCO Funds Group, Inc. is 7800 E. Union Avenue, Denver, Colorado
80237.
(7) Based on a Schedule 13G dated February 5, 2002. This interest is held by
Putnam Investments, LLC and related affiliates. The business address for
Putnam Investments, LLC is One Post Office Square, Boston, Massachusetts
02109.
(8) Owned by AT&T Corp. and related affiliates. Based on information provide
to the Company by AT&T Corp. as of February 28, 2002. The business
address of AT&T Corp. is 32 Avenue of Americas, New York, New York 10013.
(9) Based on a Schedule 13G dated February 11, 2002. The business address of
Massachusetts Financial Service Company is 500 Boylston Street, Boston,
Massachusetts 02116.
(10) Based on a Schedule 13G dated February 14, 2002. The business address of
FMR Corp. is 82 Devonshire Street, Boston, Massachusetts 02109.
(11) Based on a Schedule 13G dated February 14, 2002. The business address of
Chilton Investment Company is 1266 East Main Street, 7th Floor, Stamford,
CT 06902.
Item 13. Certain Relationships and Related Transactions
Stockholders' Agreement
The Company's Class B Stockholders entered into a Stockholders' Agreement
when the Company was reconstituted as a corporation from a limited liability
company in May 1999. The Stockholders' Agreement was amended on July 19, 2000.
AT&T Corp., a former Class B stockholder, converted its Class B shares into
Class A shares during 2001 and as a result is no longer bound by the voting
agreements and transfer restrictions described below. Subsidiaries of AOL Time
Warner Inc. and the Advance/Newhouse stockholder group presently hold all of
the Company's Class B common stock. There is no assurance that the Class B
Stockholders will not further change the Stockholders' Agreement or terminate
it, or cause the Company to waive any provision of such agreement.
51
Under the Stockholders' Agreement, the AOL Time Warner stockholder group
has the right to designate four nominees for the Board of Directors at each
annual meeting of stockholders at which directors are elected. The
Advance/Newhouse stockholder group has the right to designate one board
member. The Class B Stockholders' ability to designate any nominees depends on
the identity of the particular stockholder and the percentage of shares of
common stock owned by it. Currently each Class B stockholder must own at least
6.69% of the common stock to appoint one director. AOL Time Warner Inc. is
entitled to nominate four directors so long as it owns at least 13.37% of the
common stock. If AOL Time Warner Inc. owns less than 13.37% of the common
stock, the number of directors it may nominate decreases proportionally with
its ownership of the common stock until it owns less than 6.69%. The
Advance/Newhouse stockholder group is entitled to nominate one director as
long as it owns at least 6.69% of the common stock. None of the Class B
Stockholders have the right to designate nominees if they own less than 6.69%
of the common stock. These percentages will continue to adjust from time to
time if the Company issues additional shares of common stock or takes actions
such as stock splits or recapitalizations so as to maintain the same relative
rights.
Messrs. Britt, Davies, Hays, and Ms. Hook are the current directors
nominated by AOL Time Warner Inc. Each of these is an officer of AOL Time
Warner Inc. or one of its affiliates. There was no indebtedness or any
transactions between the Company and AOL Time Warner Inc. or its affiliates
that exceeded 5% of the Company's or AOL Time Warner Inc.'s gross consolidated
revenues for 2001. Further detail on transactions with affiliates of AOL Time
Warner Inc. is provided below under "Certain Operating Agreements." Mr. Miron
is the director nominated by the Advance/Newhouse stockholder group and is an
executive officer of Advance/Newhouse Communications. There was no
indebtedness or any transactions between the Company and Advance/Newhouse or
its affiliates that exceeded 5% of the Company's or Advance/Newhouse's gross
consolidated revenues for 2001, and the Company does not expect there to be
any such indebtedness or transactions in 2002.
The Stockholders' Agreement requires the Class B Stockholders to vote their
shares in favor of:
. the nominees selected by the holders of Class B common stock as
previously described;
. the Chief Executive Officer of the Company; and
. three nominees who are not affiliated with the Company or any holder of
Class B common stock and are selected by the Nominating Committee.
The Stockholders' Agreement prohibits the Class B Stockholders from any
transfer of Class B common stock, unless expressly permitted by the agreement.
In addition, the Stockholders' Agreement prohibits any of the Class B
Stockholders from entering into voting agreements relating to the Class B
common stock with any third party.
If a Class B Stockholder wants to sell all of its Class B common stock
pursuant to a bona fide offer from an unaffiliated third party, that
stockholder must give notice (the "Refusal Notice") to all Class B
Stockholders. The Refusal Notice must contain the identity of the offeror and
an offer to sell the stock to the other Class B Stockholders upon the same
terms and subject to the same conditions as the offer from the third party.
The non-selling holders of Class B common stock will have the right to
purchase pro rata all, but not less than all, of the Class B common stock. If
the non-selling holders fail to exercise their right to purchase all of the
shares, the selling Class B Stockholder is free, for a period of 90 days, to
sell the shares of Class B common stock (as shares of Class B common stock) to
the third party offeror on terms and conditions no less favorable to the
selling Class B Stockholder than those contained in the Refusal Notice. A
Class B Stockholder may transfer all of its right to nominate Class B nominees
for election to the Board of Directors if it sells all of its shares of Class
B common stock. If AOL Time Warner Inc. wants to sell all of its Class B
common stock and its Class A common stock that represent more than one-third
of the outstanding shares of common stock, the other holders of Class B common
stock will have certain "tag-along" rights. These rights provide them the
right to sell their shares of Class A common stock and Class B common stock on
a pro rata basis along with, and on the same terms and conditions as, AOL Time
Warner Inc. In that sale, AOL Time Warner Inc. (and any other stockholder
transferring all of its shares of Class B common stock) will have the right to
transfer its right to nominate Class B nominees for election to the Board of
Directors.
52
Except for transfers to affiliates and the other transfers described above,
all shares of Class B common stock must be converted to Class A common stock
immediately prior to any direct transfer or certain indirect transfers of
Class B common stock. In addition, except for transfers described in the
paragraph above, a stockholder will not have the right to transfer its right
to nominate Class B nominees. A Class B Stockholder that is acquired by a
third party or spins off to its stockholders a company holding its shares of
Class B common stock (as well as other assets), is required to convert its
shares into Class A common stock and its right to nominate Class B nominees to
the Board of Directors will not terminate.
The Class B Stockholders have demand registration rights for shares of
Class A common stock (including shares of Class A common stock resulting from
the conversion of shares of Class B common stock) if they wish to register
Class A common stock constituting at least 1% of the total outstanding Class A
common stock. Once the Company has registered shares of Class A common stock
as a result of a demand registration, it is not required to register shares
again, pursuant to a Class B Stockholder demand, until 180 days after the
first registration statement is effective. In addition, each Class B
Stockholder may require the Company to include its shares in certain other
registered offerings under the Securities Act of 1933, subject to certain
conditions. Each Class B Stockholder must pay all underwriting discounts,
commissions, and transfer taxes attributable to the sale of its shares. The
Company must pay all expenses related to the filing and effectiveness of a
registration statement, the legal fees of one counsel representing the Class B
Stockholders, and the auditors' fees and expenses. MediaOne Group, Inc.
exercised its demand registration rights in 2000 prior to its acquisition by
AT&T Corp. and sold 9,000,000 shares of Class A common stock in a secondary
public offering.
Restated Certificate of Incorporation
The Company's Restated Certificate of Incorporation prohibits the Company
from (i) engaging in the business of providing, offering, packaging,
marketing, promoting, or branding (alone or jointly with, or as an agent for
other parties) any residential services, or (ii) producing or otherwise
providing entertainment, information, or other content services, without the
consent of all the Class B Stockholders. This prohibition expires in May 2004
or earlier if the Class B Stockholders no longer hold 50% of the total voting
power for the Board of Directors. However, the Capacity License Agreement
extends the prohibition to 2028.
Certain Operating Agreements
Capacity License Agreements. The Company currently licenses much of its
fiber capacity from Time Warner Cable. Each of the Company's local operations
where Time Warner Cable has a network is party to a Capacity License Agreement
with the local cable television operation of Time Warner Cable, providing the
Company with an exclusive right to use all of the capacity of specified fiber
optic cable owned by the Time Warner Cable operation. The Capacity License
Agreements expire in 2028. The Capacity License Agreements for networks that
existed as of July 1998 have been fully paid and do not require additional
license fees. However, the Company must pay certain maintenance fees and fees
for splicing and similar services. The Company may request that Time Warner
Cable construct and provide additional fiber optic cable capacity to meet the
Company's needs after July 1998. Time Warner Cable is not obligated to provide
such fiber capacity and the Company is not obligated to take fiber capacity
from Time Warner Cable. As the Company expands its operations to markets not
served by Time Warner Cable, it will be required to obtain fiber capacity from
other sources. If Time Warner Cable provides additional capacity, the Company
must pay an allocable share of the cost of construction of the fiber upon
which capacity is to be provided, plus a permitting fee. The Company is
responsible for all taxes and franchise, pole, attachment, or similar fees
arising out of its use of the capacity, and a portion of other out-of-pocket
expenses incurred by Time Warner Cable for the cable used to provide the
capacity. The Company is permitted to use the capacity for telecommunications
services and any other lawful purpose, but not for the provision of
residential services and content services. If the Company violates the
limitations on business activities of the Company contained in the Restated
Certificate of Incorporation or the Capacity License Agreements, Time Warner
Cable may terminate the Capacity License Agreements. Accordingly, the Capacity
License Agreement restrictions will apply after the restrictions in the
Restated Certificate of Incorporation have
53
terminated. Although management does not believe that the restrictions in the
Capacity License Agreements will materially affect the Company's business and
operations in the immediate future, the Company cannot predict the effect of
such restrictions in the rapidly changing telecommunications industry.
The Capacity License Agreements do not restrict the Company from licensing
fiber optic capacity from parties other than Time Warner Cable. Although Time
Warner Cable has agreed to negotiate renewal or alternative provisions in good
faith upon expiration of the Capacity License Agreements, the Company cannot
assure that the parties will agree on the terms of any renewal or alternative
provisions or that the terms of any renewal or alternative provisions will be
favorable to the Company. If the Capacity License Agreements are not renewed
in 2028, the Company will have no further interest in the fiber capacity
covered by those Agreements and may need to build, lease, or otherwise obtain
transmission capacity to replace the capacity previously licensed under the
Agreements. The terms of such arrangements could have a material adverse
effect on the Company's business, financial condition, and results of
operations. The Company has the right to terminate a Capacity License
Agreement in whole or in part at any time upon 180 days' notice and payment of
any outstanding fees regarding the terminated capacity. Time Warner Cable has
the right to terminate a Capacity License Agreement upon 180 days' notice in
the event of, among other things, certain governmental proceedings or third
party challenges to Time Warner Cable's franchises or the Agreements. The
Capacity License Agreements include substantial limitations on liability for
service interruptions.
Facility Lease Agreements. The Company leases or subleases physical space
located at Time Warner Cable's facilities for various purposes under Facility
Lease Agreements. If certain events occur the Company will be required, at its
own expense, to segregate and partition its space in a reasonable, secure
manner. Those events are:
. at least a majority of any Time Warner Cable system is not owned by one
or more of the Class B Stockholders;
. AOL Time Warner Inc. owning less than 30% of the Company's common stock;
. AOL Time Warner Inc. having the right to nominate less than three
nominees to the Company's Board of Directors;
. the Company's non-compliance with the restrictions in the Restated
Certificate of Incorporation regarding residential services and content
services; or
. a Class B Stockholder transferring its Class B common stock, together
with its rights to designate nominees to the Board of Directors under
the Stockholders' Agreement.
The lease rates for properties Time Warner Cable owns and leases to the
Company are based upon comparable rents in the local market, taking into
account other factors such as the term of the lease, type of space, square
footage, location, and leasehold improvements funded. Generally, the leases
have 15-year terms, with two five-year options to renew. For properties Time
Warner Cable subleases to the Company, we pay a pro rata portion of the rent
and fees payable under the primary lease. The duration of the Company's
subleases matches the duration of Time Warner Cable's primary lease. In 2001
we paid Time Warner Cable approximately $1.7 million for rentals under the
Facility Lease Agreements.
Residential Support Agreement. The Company provides certain support
services or service elements, on an unbundled basis, to Time Warner Cable for
its residential telephony business. In addition, the Company provides limited
back office support, including usage data. Time Warner Cable paid the Company
approximately $750,000 for these services in 2001.
Time Warner Inc. License Agreement. The Company's use of the "Time Warner"
name is subject to a license agreement with Time Warner Inc., a unit of AOL
Time Warner Inc. The Company may change its name to "TW Telecom Inc." and the
Company will no longer have the right to use the "Time Warner" name upon
54
expiration of the current term in July 2004 or any renewal term of such
agreement. The Company is also required to discontinue use of the "Time
Warner" name upon:
. AOL Time Warner Inc. owning less than 30% of the Company's common stock;
. AOL Time Warner Inc. having the right to nominate less than three
nominees to the Board of Directors of the Company;
. the Company's non-compliance with the restrictions in the Restated
Certificate of Incorporation regarding residential services and content
services (see "Limitation on Residential and Content Services"); or
. the transfer by a Class B Stockholder of its Class B common stock
together with its rights to designate nominees to the Board of Directors
under the Stockholders' Agreement (however, this would not apply to a
conversion of Class B common stock to Class A common stock).
The Company believes that the "Time Warner" brand is valuable and its loss
could have an adverse effect on the Company's ability to conduct its business
and on its financial condition and results of operations.
Other Transactions. Affiliates of AOL Time Warner Inc. purchase dedicated
transport, switched, data and Internet services from the Company. Total
revenue from these customers was $25.5 million in 2001. The Company contracted
with Time Warner Cable's Construction Division to construct a distribution
ring for the Company in the Dallas area for approximately $3.9 million. The
pricing was based on competitive bids. In 2001, AOL Time Warner Inc. and its
affiliates were one of the Company's top 10 customers, accounting for
approximately 3% of the Company's total revenue.
The Company plans to participate in a trial that Time Warner Cable is
conducting in one of its cable service areas of a new voice over IP telephony
service for Time Warner Cable's residential customers. The Company anticipates
that it will provide access to the public switched telephone network for the
telephone traffic generated from the trial and possibly other support
services.
The Company believes that the terms and conditions, taken as a whole, of
the transactions described under the headings "Capacity License Agreements,"
"Facility Lease Agreements," "Services Agreement," "Residential Support
Agreements," the "Time Warner Inc. License Agreement," and "Other
Transactions" were no less favorable to the Company than it could have
obtained from unaffiliated parties.
The Class B Stockholders hold all of the Company's Class B common stock and
have the collective ability to control all matters requiring stockholder
approval, including the election of directors. All of the Class B Stockholders
are in the cable television business and may provide the same services or
similar services to those the Company provides. There is no restriction on the
Class B Stockholders' ability to compete with the Company and the Company
cannot assure that the Class B Stockholders will not compete with the Company.
The Company's directors who are also directors, officers, or employees of the
Class B Stockholders, may encounter conflicts of interest in certain business
opportunities available to, and certain transactions involving, the Company.
The Class B Stockholders have not adopted any special voting procedures to
deal with conflicts of interest, and the Company cannot assure that any
conflict will be resolved in the Company's favor.
55
GLOSSARY
Access Charges. The fees paid by long distance carriers for the local
connections between the long distance carriers' networks and the long distance
carriers' customers.
BOC (Bell Operating Company). A telephone operating subsidiary of an RBOC.
Broadcast Video TV-1. This Company service provides dedicated transport of
broadcast quality video signals.
Central Offices. A telecommunications center where switches and other
telecommunications facilities are housed. CLECs may connect with ILEC networks
either at this location or through a remote location.
Collocation. The ability of a telecommunications carrier to interconnect
its network to the ILEC's network by extending its facilities to the ILEC's
central office. Physical collocation occurs when the interconnecting carrier
places its network equipment within the ILEC's central offices. Virtual
collocation is an alternative to physical collocation under which the ILEC
permits a carrier to interconnect its network to the ILEC's network in a
manner which is technically, operationally and economically comparable to
physical collocation, even though the interconnecting carrier's network
connection equipment is not physically located within the central offices.
CLEC (Competitive Local Exchange Carrier). A company that provides local
exchange services, including dedicated service, in competition with the ILEC.
Dedicated. Telecommunications lines dedicated to, or reserved for use by, a
particular customer along predetermined routes (in contrast to links which are
temporarily established).
Dedicated Transmission. The sending of electronic signals carrying
information over a Dedicated Transport facility.
Dedicated Transport. A non-switched point-to-point telecommunications
facility leased from a telecommunications provider by an end user and used
exclusively by that end user.
Dense Wavelength Division Multiplexing (DWDM). A technology that multiplies
the capacity of single fiber to 8, 16, 32, or 80 new transmission channels.
Higher capacity multiples are under testing.
Digital. A means of storing, processing and transmitting information by
using distinct electronic or optical pulses that represent the binary digits 0
and 1. Digital transmission and switching technologies use a sequence of these
pulses to represent information as opposed to the continuously variable analog
signal. The precise digital numbers preclude distortion (such as graininess or
snow in the case of video transmission, or static or other background
distortion in the case of audio transmission).
DS-0, DS-1, DS-3. Standard North American telecommunications industry
digital signal formats, which are distinguishable by bit rate (the number of
binary digits (0 and 1) transmitted per second). DS-0 service has a bit rate
of 64 kilobits per second. DS-1 service has a bit rate of 1.544 megabits per
second and DS-3 service has a bit rate of 44.736 megabits per second. A DS-0
can transmit a single uncompressed voice conversation.
Ethernet. A network configuration in which data is separated into "frames"
for transmission. Ethernet equipment scans the network to find the least-
congested route for frames to travel from Point A to Point B, thus resulting
in greater speed and fewer errors in frame transmission.
FCC. Federal Communications Commission.
FDMA (Frequency Division Multiple Access). A form of wireless
communications technology.
56
Fiber Miles. The number of route miles of fiber optic cable installed
(excluding pending installations) along a telecommunications path multiplied
by the number of fibers in the cable. See the definition of "route mile"
below.
Fiber Optics. Fiber optic technology involves sending laser light pulses
across glass strands in order to transmit digital information. Fiber optic
cable is the medium of choice for the telecommunications and cable industries.
Fiber is immune to electrical interference and environmental factors that
affect copper wiring and satellite transmission.
Gbps (Gigabits per second). One billion bits of information. The
information-carrying capacity (i.e., bandwidth) of a circuit may be measured
in "billions of bits per second."
Hub. Collocation centers located centrally in an area where
telecommunications traffic can be aggregated for transport and distribution.
ILECs (Incumbent Local Exchange Carriers). The local phone companies,
either a BOC or an independent (such as Cincinnati Bell) which provides local
exchange services.
Internet. The name used to describe the global open network of computers
that permits a person with access to the Internet to exchange information with
any other computer connected to the network.
IntraLATA. A call that originates and terminates within the same LATA.
ISDN (Integrated Services Digital Network). ISDN is an internationally
agreed standard which, through special equipment, allows two-way, simultaneous
voice and data transmission in digital formats over the same transmission
line. ISDN permits video conferencing over a single line, for example, and
also supports a multitude of value-added switched service applications such as
Incoming Calling Line Identification. ISDN's combined voice and data
networking capabilities reduce costs for end users and result in more
efficient use of available facilities. ISDN combines standards for highly
flexible customer to network signaling with both voice and data within a
common facility.
IXC (Interexchange Carrier). A long distance carrier.
Kbps (Kilobits per second). Kilobit means one thousand bits of information.
The information-carrying capacity (i.e., bandwidth) of a circuit may be
measured in "thousands of bits per second."
LANs (Local Area Networks). The interconnection of computers for the
purpose of sharing files, programs and peripheral devices such as printers and
high-speed modems. LANs may include dedicated computers or file servers that
provide a centralized source of shared files and programs. LANs are generally
confined to a single customer's premises and may be extended or interconnected
to other locations through the use of bridges and routers.
LATA (Local Access and Transport Area). The geographical areas within which
a local telephone company may offer telecommunications services, as defined in
the divestiture order known as the Modified Final Judgment unless and until
refined by the FCC pursuant to the Telecommunications Act of 1996.
Local Exchange. A geographic area defined by the appropriate state
regulatory authority in which telephone calls generally are transmitted
without toll charges to the calling or called party.
Local Exchange Service/Local Exchange Telephone Service. Basic local
telephone service, including the provision of telephone numbers, dial tone and
calling within the local exchange area.
Long Distance Carriers (Interexchange Carriers or IXC). Long distance
carriers providing services between LATAs, on an interstate or intrastate
basis. A long distance carrier may be facilities-based or offer service by
reselling the services of a facilities-based carrier.
57
Mbps (Megabits per second). Megabit means one million bits of information.
The information carrying capacity (i.e., bandwidth) of a circuit may be
measured in "millions of bits per second."
Multiplexing. An electronic or optical process that combines a number of
lower speed transmission signals into one higher speed signal. There are
various techniques for multiplexing, including frequency division (splitting
the total available frequency bandwidth into smaller frequency slices), time
division (slicing a channel into timeslots and placing each signal into its
assigned timeslot), and statistical (wherein multiplexed signals share the
same channel and each transmits only when it has data to send).
OC-n. Optical carrier levels ranging from OC-1 (51.84 Mbps) to OC-192 (9.9
Gbps).
Node. A point of connection into a fiber optic network.
POPs (Points of Presence). Locations where an IXC has installed
transmission equipment in a service area that serves as, or relays telephone
calls to, a network switching center of the same IXC.
Primary Rate Interface (PRI). A transport mechanism provided currently over
class 5 switches to terminate at managed modem pools. The primary application
is for dial-up Internet access.
Private Line. A private, dedicated telecommunications link between
different customer locations (excluding IXC POPs).
Public Switched Telephone Network. The switched network available to all
users generally on a shared basis (i.e., not dedicated to a particular user).
The local exchange telephone service networks operated by ILECs are the
largest and often the only public switched networks in a given locality.
RBOC (Regional Bell Operating Company). The holding company which owns a
BOC.
Reciprocal Compensation. An arrangement in which two local exchange
carriers agree to terminate traffic originating on each other's networks in
exchange for a negotiated level of compensation.
Redundant Electronics. A telecommunications facility that uses two separate
electronic devices to transmit a telecommunications signal so that if one
device malfunctions, the signal may continue without interruption.
Route Mile. The number of miles along which fiber optic cables are
installed.
SONET (Synchronous Optical Network). A set of standards for optical
communications transmission systems that define the optical rates and formats,
signal characteristics, performance, management and maintenance information to
be embedded within the signals and the multiplexing techniques to be employed
in optical communications transmission systems. SONET facilitates the
interoperability of dissimilar vendors equipment. SONET benefits business
customers by minimizing the equipment necessary for various telecommunications
applications and supports networking diagnostic and maintenance features.
Special Access Services. The lease of private, dedicated telecommunications
lines or circuits on an ILEC's or a CLECs network which run to or from the
IXC's POPs. Special access services do not require the use of switches.
Examples of special access services are telecommunications circuits running
between POPs of a single IXC, from one IXC's POP to another IXC's POP or from
an end user to its IXC's POP.
SS7. A standard signaling system used by telephone providers to manage line
supervision (determining whether a line is "busy" or "free"), call alert
("ringing" the phone to indicate an incoming call), and call routing. SS7
allows companies to offer optional service features such as caller ID, call
forwarding, etc.
STS-1. This dedicated transmission service is carried over high-capacity
channels for full duplex, synchronous optical transmission of digital data on
SONET standards. This service eliminates the need to maintain and pay for
multiple dedicated lines.
58
Switch. A mechanical or electronic device that opens or closes circuits or
selects the paths or circuits to be used for the transmission of information.
Switching is a process of linking different circuits to create a temporary
transmission path between users. Within this document, switches generally
refer to voice grade telecommunications switches unless specifically stated
otherwise.
Switched Access Services. The connection between an IXC's POP and an end
user's premises through the switching facilities of a local exchange carrier.
Switched Services. Telecommunications services that support the connection
of one calling party with another calling party via use of a telephone switch
(i.e., an electronic device that opens or closes circuits, completes or breaks
an electrical path, or selects paths or circuits).
Toll Services. Otherwise known as EAS or intraLATA toll services are those
calls that are beyond the free local calling area but originate and terminate
within the same LATA; such calls are usually priced on a measured basis.
Voice Grade Equivalent (VGE) Circuit. One DS-0. One voice grade equivalent
circuit is equal to 64 kilobits of bandwidth.
59
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K
(a) (1), (2) The Financial Statements and Schedule II--Valuation and
Qualifying Accounts listed on the index on Page F-1 following are included
herein by reference. All other schedules are omitted, either because they are
not applicable or because the required information is shown in the financial
statements or the notes thereto.
(3) Exhibits:
Exhibit
Number Description of Exhibit
------- ----------------------
2.1 --Reorganization Agreement among Time Warner Companies, Inc., MediaOne
Group, Inc., Advance/Newhouse Partnership, Time Warner Entertainment
Company, L.P., and Time Warner Entertainment-Advance/Newhouse
Partnership (filed as Exhibit 2.1 to Company's Quarterly Report on
Form 10-Q for the quarter ended June 30, 1998)*
2.2 --Merger Agreement among the Company, Time Warner Telecom LLC and Time
Warner Telecom Inc. (filed as Exhibit 2.2 to the Company's
Registration Statement on Form S-1 (Registration No. 333-49439))*
2.3 --Asset Purchase Agreement dated as of September 11, 2000 among Time
Warner Telecom Inc., GST Telecommunications, Inc., GST USA, Inc. and
the other parties identified on Exhibit A thereto (filed as Exhibit
2.1 to the Company's Report on Form 8-K dated September 18, 2000 and
dated September 11, 2000). *
3.1 --Restated Certificate of Incorporation of the Company (filed as
Exhibit 3.1 to Company's Registration Statement on Form S-1
(Registration No. 333-49439))*
3.2 --Restated By-laws of the Company (filed as Exhibit 3.2 to Company's
Registration Statement on Form S-1 (Registration No. 333-49439))*
4.1 --Stockholders' Agreement, among the Company, Time Warner Companies,
Inc., American Television and Communications Corporation, Warner
Communications Inc., TW/TAE Inc., FibrCom Holdings, L.P., Paragon
Communications, MediaOne Group, Inc., Multimedia Communications, Inc.
and Advance/Newhouse Partnership (filed as Exhibit 4.1 to Company's
Registration Statement on Form S-1 (Registration No. 333-49439))*
4.2 --Amendment No. 1 to Stockholders' Agreement among Time Warner Telecom
Inc., Time Warner Companies Inc., American Television and
Communications Corporation, Warner Communications Inc., TW/TAI Inc.
FibrCom Holdings, L.P., MediaOne of Colorado, Inc. and
Advance/Newhouse Partnerships.*
4.3 --Indenture between Time Warner Telecom LLC, TWT Inc. and The Chase
Manhattan Bank, as Trustee (filed as Exhibit 4.1 to Time Warner
Telecom LLC's Quarterly Report on Form 10-Q for the quarter ended
June 30, 1998)*
4.4 --Indenture between Time Warner Telecom Inc. and The Chase Manhattan
Bank, as Trustee (filed as Exhibit 4 to Amendment No. 1 to the
Company's Registration Statement on Form S-3 (Registration No. 333-
49818)) *
10.1 --Lease between Quebec Court Joint Venture No. 2, Landlord, and
Intelligent Advanced Systems, Inc., Tenant, dated June 3, 1994 (filed
as Exhibit 10.1 to Time Warner Telecom LLC's Registration Statement
on Form S-1 (Registration No. 333-53553))*
10.2 --Agreement for Assignment of Lease, dated September 12, 1997, between
Ingram Micro Inc. and Time Warner Communications Holdings Inc. (filed
as Exhibit 10.2 to Time Warner Telecom LLC's Registration Statement
on Form S-1 (Registration No. 333-53553))*
10.3 --First Amendment to Lease, dated October 15, 1997, by CarrAmerica
Realty, L.P. and Time Warner Communications Holdings Inc. (filed as
Exhibit 10.3 to Time Warner Telecom LLC's Registration Statement on
Form S-1 (Registration No. 333-53553))*
10.4 --Time Warner Telecom Inc. 1998 Stock Option Plan as amended December
8, 1999 (filed as Exhibit 10.4 to the Company's Registration
Statement on Form S-1 (Registration No. 333-49439))*
60
Exhibit
Number Description of Exhibit
------- ----------------------
10.5 --Employment Agreement between the Company and Larissa L. Herda (filed
as Exhibit 10.5 to the Company's Annual Report on Form 10-K for the
year ended December 31, 1999)*
10.6 --Employment Agreement between the Company and Paul B. Jones (filed as
Exhibit 10.6 to the Company's Annual Report on Form 10-K for the year
ended December 31, 1999)*
10.7 --Employment Agreement between the Company and A. Graham Powers (filed
as Exhibit 10.7 to the Company's Annual Report on Form 10-K for the
year ended December 31, 1999)*
10.8 --Employment Agreement between the Company and David Rayner (filed as
Exhibit 10.8 to the Company's Annual Report on Form 10-K for the year
ended December 31, 1999)*
10.9 --Employment Agreement between the Company and John T. Blount (filed
as Exhibit 10.9 to the Company's Annual Report on Form 10-K for the
year ended December 31, 1999)*
10.10 --Employment Agreement between the Company and Michael Rouleau (filed
as Exhibit 10.10 to the Company's Annual Report on Form 10-K for the
year ended December 31, 1999)*
10.11 --Employment Agreement between the Company and Julie Rich (filed as
Exhibit 10.11 to the Company's Annual Report on Form 10-K for the
year ended December 31, 1999)*
10.12 --Capacity License Agreement (filed as Exhibit 10.3 to Quarterly
Report on Form 10-Q for the quarter ended June 30, 1998)*
10.13 --Trade Name License Agreement (filed as Exhibit 10.4 to Quarterly
Report on Form 10-Q for the quarter ended June 30, 1998)*
10.14 --Master Capacity Agreement between MCImetro Access Transmission
Services, Inc. and Time Warner Communications dated September 9,
1994, as amended on September 9, 1999 and August 28, 1997 (filed as
Exhibit 10.12 to the Company's Registration Statement on Form S-1
(Registration No. 333-49439))*
10.15 --Time Warner Telecom Inc. 2000 Employee Stock Plan (filed as Exhibit
4.3 to the Company's Registration Statement on Form S-8, Registration
No. 333-48084)*
10.16 --Amended and Restated Credit Agreement among Time Warner Telecom
Inc., Time Warner Telecom Holdings Inc., the several lenders from
time to time parties thereto, The Chase Manhattan Bank, Bank of
America, N.A., Morgan Stanley Senior Funding, Inc. and ABN Amro Bank
N.V. (filed as Exhibit 10.18 to the Company's Annual Report on Form
10-K for the year ended December 31, 2000)*
21 --Subsidiaries of the Company
23 --Consent of Ernst & Young LLP, Independent Auditors
- --------
* Incorporated by reference.
(b) Reports on Form 8-K.
--Form 8-K filed November 7, 2001 providing the November 8, 2001
14.1 investor presentation.
61
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, as amended, the Registrant has duly caused this report
to be signed on its behalf by the undersigned, thereunto duly authorized, on
March 25, 2002.
TIME WARNER TELECOM INC.
/s/ David J. Rayner
By: _________________________________
David J. Rayner
Senior Vice President and Chief
Financial Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, this report has been signed below by the following persons on behalf
of the Registrant in the capacities and on the dates indicated.
Signature Title Date
- --------- ----- ----
(i) Principal Executive Officer
/s/ Larissa L. Herda Chairman, President, and March 25, 2002
______________________________________ Chief Executive Officer
Larissa L. Herda
(ii) Principal Financial Officer
/s/ David J. Rayner Senior Vice President and March 25, 2002
______________________________________ Chief Financial Officer
David J. Rayner
(iii) Principal Accounting Officer
/s/ Jill R. Stuart Vice President, Accounting March 25, 2002
______________________________________ and Finance and Chief
Jill R. Stuart Accounting Officer
(iv) Directors
/s/ Glenn A. Britt Director March 25, 2002
______________________________________
Glenn A. Britt
/s/ Bruce L. Claflin Director March 25, 2002
______________________________________
Bruce L. Claflin
/s/ Richard J. Davies Director March 25, 2002
______________________________________
Richard J. Davies
/s/ Spencer B. Hays Director March 25, 2002
______________________________________
Spencer B. Hays
62
/s/ Larissa L. Herda Director March 25, 2002
______________________________________
Larissa L. Herda
/s/ Lisa A. Hook Director March 25, 2002
______________________________________
Lisa A. Hook
/s/ Robert J. Miron Director March 25, 2002
______________________________________
Robert J. Miron
/s/ Theodore H. Schell Director March 25, 2002
______________________________________
Theodore H. Schell
63
TIME WARNER TELECOM INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
----
Audited Financial Statements:
Report of Independent Auditors.......................................... F-2
Consolidated Balance Sheets at December 31, 2001 and 2000............... F-3
Consolidated Statements of Operations for the years ended December 31,
2001, 2000, and 1999................................................... F-4
Consolidated Statements of Cash Flows for the years ended December 31,
2001, 2000, and 1999................................................... F-5
Consolidated Statements of Changes in Stockholders' Equity for the years
ended December 31, 2001, 2000, and 1999................................ F-6
Notes to Consolidated Financial Statements.............................. F-7
Schedule II--Valuation and Qualifying Accounts............................ F-25
F-1
REPORT OF INDEPENDENT AUDITORS
To the Board of Directors of Time Warner Telecom Inc:
We have audited the accompanying consolidated balance sheets of Time Warner
Telecom Inc. (the "Company") as of December 31, 2001 and 2000, and the related
consolidated statements of operations, cash flows, and stockholders' equity
for each of the three years in the period ended December 31, 2001. Our audits
also included the financial statement schedule listed on the index at page F-
1. These financial statements and schedule are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements and schedule based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on
a test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used
and significant estimates made by management, as well as evaluating the
overall financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of the Company
at December 31, 2001 and 2000, and the consolidated results of its operations
and its cash flows for each of the three years in the period ended December
31, 2001, in conformity with accounting principles generally accepted in the
United States. Also, in our opinion, the related financial statement schedule,
when considered in relation to the basic financial statements taken as a
whole, presents fairly, in all material respects the information set forth
therein.
/s/ Ernst & Young LLP
Denver, Colorado
January 30, 2002
F-2
TIME WARNER TELECOM INC.
CONSOLIDATED BALANCE SHEETS
December 31, 2001 and 2000
2001 2000
---------- ---------
(amounts in
thousands, except
share amounts)
ASSETS
Current assets:
Cash and cash equivalents............................. $ 365,600 71,739
Cash held in escrow................................... -- 179,000
Marketable debt securities (note 4)................... 18,454 3,496
Receivables, less allowances of $29,778 and $17,610,
respectively......................................... 78,431 83,027
Prepaid expenses...................................... 3,305 2,505
Deferred income taxes................................. 35,570 34,418
---------- ---------
Total current assets................................ 501,360 374,185
---------- ---------
Property, plant and equipment........................... 2,286,278 1,195,744
Less accumulated depreciation......................... (475,182) (283,572)
---------- ---------
1,811,096 912,172
---------- ---------
Deferred income taxes................................... 23,630 --
Intangible and other assets, net of accumulated
amortization (notes 1 and 2)........................... 62,868 101,397
---------- ---------
Total assets........................................ $2,398,954 1,387,754
========== =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable...................................... $ 79,429 72,041
Deferred revenue...................................... 47,528 53,286
Accrued taxes, franchise and other fees............... 65,210 40,343
Accrued interest...................................... 38,102 19,904
Accrued payroll and benefits.......................... 28,008 23,651
Payable to Time Warner Cable (note 6)................. 4,794 4,161
Accrued restructure costs (note 3).................... 3,131 --
Accrued carrier costs................................. 77,018 34,900
Other current liabilities............................. 43,653 36,431
---------- ---------
Total current liabilities........................... 386,873 284,717
---------- ---------
Long-term debt and capital lease obligations (notes 5
and 9)................................................. 1,063,368 585,107
Deferred income taxes (note 7).......................... -- 46,163
Stockholders' equity (note 1):
Preferred stock, $0.01 par value, 20,000,000 shares
authorized, no shares issued and outstanding......... -- --
Class A common stock, $0.01 par value, 277,300,000
shares authorized, 48,789,111 and 33,702,461 shares
issued and outstanding in 2001 and 2000,
respectively......................................... 488 337
Class B common stock, $0.01 par value, 162,500,000
shares authorized, 65,936,658 and 72,226,500 shares
issued and outstanding in 2001 and 2000,
respectively......................................... 659 722
Additional paid-in capital............................ 1,165,804 601,081
Accumulated other comprehensive income (loss), net of
taxes................................................ (206) 6,492
Accumulated deficit................................... (218,032) (136,865)
---------- ---------
Total stockholders' equity.......................... 948,713 471,767
---------- ---------
Total liabilities and stockholders' equity.......... $2,398,954 1,387,754
========== =========
See accompanying notes
F-3
TIME WARNER TELECOM INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
Years Ended December 31, 2001, 2000, and 1999
2001 2000 1999
--------- ------- -------
(amounts in thousands,
except per share amounts)
Revenue(a):
Dedicated transport services................... $ 425,401 263,913 152,468
Switched services.............................. 312,306 223,421 116,285
--------- ------- -------
Total revenue................................ 737,707 487,334 268,753
--------- ------- -------
Costs and expenses(b):
Operating...................................... 315,682 184,995 117,567
Selling, general and administrative............ 237,698 170,722 113,389
Depreciation and amortization.................. 207,571 95,295 68,785
Restructure charge............................. 6,838 -- --
--------- ------- -------
Total costs and expenses..................... 767,789 451,012 299,741
--------- ------- -------
Operating income (loss).......................... (30,082) 36,322 (30,988)
Interest expense(b).............................. (115,080) (41,230) (45,264)
Interest income.................................. 18,703 10,821 16,589
Investment losses, net........................... (2,964) -- --
Equity in income of unconsolidated affiliate
(note 2)........................................ -- -- 202
--------- ------- -------
Net income (loss) before income taxes............ (129,423) 5,913 (59,461)
Income tax expense (benefit) (note 7)............ (48,256) 4,697 29,804
--------- ------- -------
Net income (loss)................................ $ (81,167) 1,216 (89,265)
========= ======= =======
Basic and diluted earnings (loss) per common
share........................................... $ (0.71) 0.01 (0.93)
Weighted average shares outstanding:
Basic.......................................... 113,730 105,391 95,898
========= ======= =======
Diluted........................................ 113,730 108,452 95,898
========= ======= =======
(a) Includes revenue resulting from transactions
with affiliates (note 6)..................... $ 25,544 11,237 3,599
========= ======= =======
(b) Includes expenses resulting from transactions
with affiliates (note 6):
Operating.................................... $ 2,751 2,727 2,513
========= ======= =======
Selling, general and administrative.......... $ 1,644 1,550 1,579
========= ======= =======
Depreciation and amortization................ $ 13,352 11,343 10,792
========= ======= =======
Interest expense............................. $ -- -- 5,078
========= ======= =======
See accompanying notes
F-4
TIME WARNER TELECOM INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31, 2001, 2000, and 1999
2001 2000 1999
---------- -------- --------
(amounts in thousands)
Cash flows from operating activities:
Net income (loss)............................. $ (81,167) 1,216 (89,265)
Adjustments to reconcile net income (loss) to
net cash provided by operating activities:
Depreciation and amortization................. 207,571 95,295 68,785
Amortization of deferred debt issue costs..... 4,484 1,652 1,250
Impairment of assets related to restructure
charge....................................... 2,359 -- --
Equity in income of unconsolidated
affiliate.................................... -- -- (202)
Impairment of deferred debt issue costs....... 5,814 -- --
Investment losses, net........................ 2,964 -- --
Deferred income tax expense (benefit)......... (49,314) 3,338 29,804
Changes in operating assets and liabilities,
net of the effect of acquisitions:
Receivables and prepaid expenses............. 31,701 (29,942) (22,384)
Accounts payable............................. 11,336 7,363 27,491
Accrued interest............................. 17,994 1,921 650
Payable to Time Warner Cable................. 633 (924) (11,716)
Accrued payroll and benefits................. 4,357 9,706 5,124
Other current liabilities.................... 35,371 75,634 44,698
Accrued restructure costs.................... 3,131 -- --
---------- -------- --------
Net cash provided by operating activities... 197,234 165,259 54,235
---------- -------- --------
Cash flows from investing activities:
Capital expenditures.......................... (425,452) (320,703) (221,224)
Cash paid for acquisitions, net of cash
acquired..................................... (651,689) (10,000) (2,565)
Purchases of marketable debt securities....... (89,582) (95,199) (290,811)
Proceeds from maturities of marketable debt
securities................................... 74,624 265,688 367,683
Other investing activities.................... 4,293 (18,378) --
---------- -------- --------
Net cash used in investing activities....... (1,087,806) (178,592) (146,917)
---------- -------- --------
Cash flows from financing activities:
Net proceeds from issuance of common stock.... 532,178 -- --
Net proceeds from issuance of debt............ 1,160,667 179,000 --
Deferred debt issue costs..................... -- (21,457) --
Repayment of debt............................. (700,000) -- --
Net proceeds from issuance of common stock
upon exercise of stock options............... 13,457 14,068 3,806
Net proceeds from issuance of common stock in
connection with the employee stock purchase
plan......................................... 1,968 3,992 --
Payment of capital lease obligations.......... (2,837) (2,117) (174)
Net proceeds from initial public offering..... -- -- 270,182
Repayment of loans to Former Parent
Companies.................................... -- -- (180,018)
Repayment of acquired debt.................... -- -- (15,668)
---------- -------- --------
Net cash provided by financing activities... 1,005,433 173,486 78,128
---------- -------- --------
Increase (decrease) in cash, cash
equivalents, and cash held in escrow....... 114,861 160,153 (14,554)
Cash, cash equivalents, and cash held in
escrow at beginning of year................ 250,739 90,586 105,140
---------- -------- --------
Cash, cash equivalents, and cash held in
escrow at end of year...................... $ 365,600 250,739 90,586
========== ======== ========
Supplemental disclosures of cash flow
information:
Cash paid for interest...................... $ 93,720 41,785 47,011
========== ======== ========
Tax benefit related to exercise of non-
qualified stock options.................... $ 17,205 23,083 2,678
========== ======== ========
Cash paid for income taxes.................. $ 992 615 168
========== ======== ========
Supplemental schedule for noncash investing and financing activities:
In 1999, Time Warner Telecom Inc. (the "Company") issued Class A common stock
aggregating $27.9 million to purchase the common stock of Internet Connect,
Inc. and MetroComm, Inc.
In 2000 and 1999, the Company incurred capital lease obligations of $6.3
million and $3.7 million, respectively for the purchase of fiber, equipment,
and furniture.
See accompanying notes
F-5
TIME WARNER TELECOM INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
Years Ended December 31, 2001, 2000, and 1999
Accumulated
Common Stock other
---------------------------- comprehensive
Class A Class B Additional income Total
------------- -------------- paid-in (loss), net Accumulated stockholders'
Shares Amount Shares Amount capital of taxes deficit equity
------ ------ ------ ------ ---------- ------------- ----------- -------------
(amounts in thousands)
Balance at January 1,
1999................... -- $ -- 81,250 $813 255,654 -- (48,816) 207,651
Initial public offering
net of offering
expenses of $19,618
(note 1)............... 20,700 207 -- -- 269,975 -- -- 270,182
Issuance of common stock
for acquisitions (note
2)..................... 2,498 25 -- -- 27,839 -- -- 27,864
Issuance of common stock
upon exercise of stock
options................ 309 2 -- -- 6,482 -- -- 6,484
Conversion of shares by
related party.......... 36 1 (36) (1) -- -- -- --
Net loss................ -- -- -- -- -- -- (89,265) (89,265)
------ ---- ------ ---- --------- ------ -------- -------
Balance at December 31,
1999................... 23,543 $235 81,214 $812 559,950 -- (138,081) 422,916
Change in unrealized
holding gain for
available-for-sale
security, net of
taxes.................. -- -- -- -- -- 6,492 -- 6,492
Net income.............. -- -- -- -- -- -- 1,216 1,216
-------
Comprehensive income... -- -- -- -- -- -- -- 7,708
-------
Shares issued for cash
in connection with the
exercise of stock
options................ 1,080 11 -- -- 37,140 -- -- 37,151
Shares issued for cash
in connection with the
employee stock purchase
plan................... 92 1 -- -- 3,991 -- -- 3,992
Conversion of shares by
related party
(note 1)............... 8,987 90 (8,987) (90) -- -- -- --
------ ---- ------ ---- --------- ------ -------- -------
Balance at December 31,
2000................... 33,702 $337 72,227 $722 601,081 6,492 (136,865) 471,767
Change in unrealized
holding loss for
available-for-sale
security, net of
taxes.................. -- -- -- -- -- (5,108) -- (5,108)
Net loss................ -- -- -- -- -- -- (81,167) (81,167)
-------
Comprehensive loss...... -- -- -- -- -- -- -- (86,275)
-------
Realized holding gain on
available-for sale
security, net of tax... -- -- -- -- -- (1,590) -- (1,590)
Issuance of common
stock, net of offering
expenses of $24,243
(note 1)............... 7,475 75 -- -- 532,103 -- -- 532,178
Shares issued for cash
in connection with the
exercise of stock
options................ 947 9 -- -- 30,487 -- -- 30,496
Shares issued in
connection with
restricted stock
awards................. 275 3 -- -- 166 -- -- 169
Shares issued for cash
in connection with the
employee stock purchase
plan................... 100 1 -- -- 1,967 -- -- 1,968
Conversion of shares by
related party
(note 1)............... 6,290 63 (6,290) (63) -- -- -- --
------ ---- ------ ---- --------- ------ -------- -------
Balance at December 31,
2001................... 48,789 $488 65,937 $659 1,165,804 (206) (218,032) 948,713
====== ==== ====== ==== ========= ====== ======== =======
See accompanying notes
F-6
TIME WARNER TELECOM INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Organization and Summary of Significant Accounting Policies
Description of Business and Capital Structure
Time Warner Telecom Inc. (the "Company"), a Delaware corporation, is a
fiber facilities-based provider of metropolitan and regional optical broadband
networks and services to business customers in 44 metropolitan markets in the
United States. The Company delivers broadband data, dedicated Internet access,
local voice, and local and long distance voice services.
Time Warner Cable (now a unit of AOL Time Warner Inc.) began the Company's
business in 1993. In 1997, the Company's business changed substantially with
an exclusive focus on business customers and a rapid expansion into switched
services and geographic areas beyond the Time Warner Cable footprint.
In July 1998, the Company was reorganized into a limited liability company,
Time Warner Telecom LLC ("TWT LLC"), and conducted an offering of $400 million
principal amount of 9 3/4% Senior Notes due July 2008. In the transaction,
referred to as the "Reorganization," Time Warner Inc. (now wholly owned by AOL
Time Warner Inc.), MediaOne Group, Inc. (now wholly owned by AT&T Corp.), and
Advance/Newhouse Partnership either directly or through subsidiaries, became
the owners of all the limited liability company interests in TWT LLC.
In May 1999, in preparation for the Company's initial public offering, TWT
LLC was reconstituted as a Delaware corporation (the "Reconstitution") under
the name Time Warner Telecom Inc. by merging into a newly formed Delaware
corporation. The Company accounted for the Reorganization and the
Reconstitution at each of the Class B Stockholders' historical cost basis and,
except as noted below, the Reorganization and Reconstitution had no effect on
the Company's total stockholders' equity, which has been presented on a
consistent basis. In connection with the Reconstitution, the Company's
capitalization was authorized to include two classes of common stock, Class A
common stock and Class B common stock. As part of the merger, the outstanding
Class A limited liability company interests were converted into Class A common
stock and the Class B Stockholders exchanged their Class B limited liability
company interests in TWT LLC for Class B common stock of the newly formed
corporation, Time Warner Telecom Inc. Prior to the Reconstitution, the only
outstanding Class A interests were those held by the former shareholders of
Internet Connect, Inc., which the Company acquired in April 1999 (see note 2).
The accompanying financial statements have been adjusted to retroactively
reflect the authorization and issuance of the shares of Class A common stock
and Class B common stock for all periods presented.
On May 14, 1999, in conjunction with the Reconstitution, the Company
completed an initial public offering of 20,700,000 shares of Class A common
stock at a price of $14 per share (the "IPO"). The IPO generated $270.2
million in proceeds for the Company, net of underwriting discounts and
expenses. The net proceeds were used primarily to repay indebtedness to the
former holders of Class B limited liability company interests in TWT LLC (see
note 6). The remaining IPO proceeds were used to repay assumed debt from
acquisitions and to fund capital expenditures.
As a result of the IPO, the Company has two classes of common stock
outstanding, Class A common stock and Class B common stock. Holders of Class A
common stock have one vote per share, and holders of Class B common stock have
ten votes per share. Each share of Class B common stock is convertible, at the
option of the holder, into one share of Class A common stock. Currently the
Class B common stock is collectively owned directly or indirectly by AOL Time
Warner Inc. ("AOL Time Warner"), Advance Telecom Holdings Corporation, and
Newhouse Telecom Holdings Corporation (collectively, the "Class B
Stockholders"). Holders of Class A common stock and Class B common stock
generally vote together as a single class. However, some matters require the
approval of 100% of the holders of the Class B common stock voting separately
as a class, and some matters require the approval of a majority of the holders
of the Class A common stock, voting separately as a
F-7
TIME WARNER TELECOM INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
class. As of December 31, 2001, the Class B Stockholders had approximately 93%
of the combined voting power of the outstanding common stock and were
represented by five members of the Board of Directors.
MediaOne Group, Inc. ("MediaOne"), a former holder of Class B common stock,
completed an underwritten offering on May 1, 2000 of 9,000,000 shares of Class
A common stock of the Company, 8,987,785 of which were converted from shares
of Class B common stock. The Company did not receive any proceeds nor did its
total shares outstanding change as a result of this transaction. On June 15,
2000, MediaOne merged with AT&T Corp. ("AT&T"), and the Class B common stock
previously beneficially owned by a MediaOne subsidiary became beneficially
owned by AT&T. In June 2001, AT&T converted its remaining 6,289,872 shares of
Class B common stock into Class A common stock.
On January 29, 2001, the Company completed a public offering of 7,475,000
shares of Class A common stock at a price of $74 7/16 per share (the
"Offering"). The Offering generated $532 million in proceeds for the Company,
net of underwriting discounts and expenses. Also, on January 25, 2001, the
Company completed a private placement of $400 million principal amount of 10
1/8% Senior Notes due February 2011 (the "Old Notes"). Pursuant to an exchange
offer in March 2001, all of the holders of the Old Notes exchanged their Old
Notes for new 10 1/8% Senior Notes due February 2011 (the "10 1/8% Senior
Notes") with the same financial terms that were registered under the
Securities Act of 1933. The Company used all of the net proceeds from the
Offering and a portion of the net proceeds from the offering of the Old Notes
to repay a $700 million senior unsecured bridge facility that initially
financed the acquisition of substantially all of the assets of GST
Telecommunications, Inc. ("GST") (see note 2). The remaining net proceeds from
the offering of the Old Notes are being used for capital expenditures, working
capital, and general corporate purposes.
The Company also is authorized to issue shares of Preferred Stock. The
Company's Board of Directors has the authority to establish voting powers,
preferences, and special rights for the Preferred Stock. No such voting
powers, preferences, or special rights have been established and no shares of
Preferred Stock have been issued as of December 31, 2001.
Basis of Presentation
These financial statements are presented as if the Company had operated as
a corporation for all periods reported. However, prior to the Reconstitution,
the Company operated as a partnership for tax purposes.
Basis of Consolidation
The consolidated financial statements include the accounts of the Company
and all entities in which the Company has a controlling voting interest
("subsidiaries"). Significant intercompany accounts and transactions have been
eliminated. Significant accounts and transactions with AOL Time Warner and its
subsidiaries are disclosed as related party transactions.
Cash Equivalents
The Company considers all highly liquid debt instruments with an original
maturity of three months or less, when purchased, to be cash equivalents.
Investments
The Company records its marketable securities in conformity with the
provisions of Statement of Financial Accounting Standards ("SFAS") No. 115,
Accounting for Certain Investments in Debt and Equity Securities. This
statement entails categorizing all debt and equity securities as held-to-
maturity securities, trading securities, or available-for-sale securities, and
then measuring the securities at either fair value or amortized cost.
F-8
TIME WARNER TELECOM INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Management determines the appropriate classification of marketable debt
securities at the time of purchase and reevaluates the designation as of each
balance sheet date. Marketable debt securities are classified as held-to-
maturity when the Company has the positive intent and ability to hold the
securities to maturity. Held-to-maturity securities are stated at amortized
cost and adjusted for amortization of premiums and accretion of discounts to
maturity. Amortization is included in interest income. Interest on marketable
securities classified as held-to-maturity is included in interest income.
Marketable equity securities held by the Company are classified as
available-for-sale. Accordingly, these securities are included in other assets
at fair value. Unrealized holding gains and losses on securities classified as
available-for-sale are carried net of taxes as a component of accumulated
other comprehensive income (loss) in stockholders' equity. Other equity
investments, which are not considered marketable securities and in which
ownership interest is less than 20%, are generally carried at the lower of
cost or net realizable value. Realized gains and losses are determined on a
specific identification basis. During 2001, the Company recognized an
aggregate $5.5 million impairment on these investments. As of December 31,
2001, the remaining book value of these investments was $1.5 million.
At December 31, 2001 and 2000, the fair value of the Company's available-
for-sale security was $1.8 million and $13.9 million, respectively. The
unrealized holding gain (loss) on this marketable equity security is reported
as accumulated other comprehensive income (loss), net of taxes, in the
accompanying consolidated financial statements. As of December 31, 2001 and
2000, the unrealized holding gain (loss) on this security was $(206,000) and
$6.5 million net of taxes, respectively. During 2001, the Company liquidated a
portion of its investment in this security for proceeds of $3.4 million,
resulting in a pretax gain of $2.5 million. There were no sales of marketable
equity securities for the years ended December 31, 2000 and 1999,
respectively.
Investments in entities in which the Company has significant influence, but
less than a controlling interest, are accounted for using the equity method.
During the first quarter of 1999, the Company's investment in unconsolidated
affiliates consisted solely of a 50% investment in MetroComm AxS, L.P.
("MetroComm L.P."), a joint venture providing commercial telecommunications
services in the central Ohio area. Under the equity method, only the Company's
investment in and amounts due to and from the equity investee were included in
the consolidated balance sheets, and only the Company's share of the
investee's income was included in the consolidated and combined statements of
operations. The Company acquired the remaining 50% of MetroComm L.P. in the
second quarter of 1999 (see note 2) and, accordingly, has accounted for this
investment on a consolidated basis since that time.
Receivables
The Company does not require significant collateral for telecommunication
services provided to customers. However, the Company performs ongoing credit
evaluations of its customers' financial conditions and has provided an
allowance for doubtful accounts based on the expected collectability of all
accounts receivable. The allowance for doubtful accounts was $29.8 million and
$17.6 million as of December 31, 2001 and 2000, respectively.
Property, Plant, and Equipment
Property, plant, and equipment are recorded at cost. Construction costs,
labor, applicable overhead related to the development, installation, and
expansion of the Company's networks, and interest costs related to
construction are capitalized. Capitalized labor and applicable overhead was
$35.4 million, $11.8 million, and $6.9 million for 2001, 2000, and 1999,
respectively. Capitalized interest was $7.1 million, $4.1 million, and $0.3
million for 2001, 2000, and 1999, respectively. Repairs and maintenance costs
are charged to expense when incurred.
F-9
TIME WARNER TELECOM INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The Company licenses the right to use fiber optic capacity in 23 of its 44
markets from Time Warner Cable. The cost of these rights, which are prepaid by
the Company, is capitalized and reflects an allocable share of Time Warner
Cable's costs, which prior to the Reorganization, generally reflected the
incremental costs incurred by Time Warner Cable to construct the fiber for the
Company. Subsequent to the Reorganization, the Company pays its allocable
share of the cost of fiber and construction incurred by Time Warner Cable in
routes where the parties are in joint construction.
Depreciation is provided on the straight-line method over estimated useful
lives as follows:
Buildings and improvements........................................ 5-20 years
Communications networks........................................... 5-15 years
Vehicles and other equipment...................................... 3-10 years
Fiber optics and right to use..................................... 15 years
Depreciation expense totaled $204.7 million, $91.9 million, and $66.1
million in 2001, 2000, and 1999, respectively.
Property, plant, and equipment consist of:
December 31,
---------------------
2001 2000
---------- ---------
(amounts in
thousands)
Buildings and improvements............................ $ 57,900 22,156
Communications networks............................... 1,364,541 816,651
Vehicles and other equipment.......................... 157,256 110,167
Fiber optics and right to use......................... 706,581 246,770
---------- ---------
2,286,278 1,195,744
Less accumulated depreciation......................... (475,182) (283,572)
---------- ---------
Total................................................. $1,811,096 912,172
========== =========
Intangible Assets
Intangible assets primarily consist of goodwill, deferred debt issue costs,
deferred right-of-way costs, and covenants not to compete, which are amortized
over periods of 10 to 20 years using the straight-line method. The Company's
goodwill was primarily generated from the acquisitions of Internet Connect,
Inc. and MetroComm L.P. in 1999. Amortization and interest expense related to
all intangible assets totaled $7.4 million, $5.0 million, and $2.7 million for
2001, 2000, and 1999, respectively. Accumulated amortization of intangible
assets at December 31, 2001 and 2000 amounted to $19.4 million and $12.0
million, respectively.
Impairment of Long-Lived Assets
The Company periodically reviews the carrying amounts of property, plant,
and equipment and its identifiable intangible assets to determine whether
current events or circumstances warrant adjustments to the carrying amounts.
If an impairment adjustment is deemed necessary (generally when the net book
value of an asset exceeds the expected future undiscounted cash flows to be
generated by that asset), the loss is measured by the amount that the carrying
value of the assets exceeds their fair value. Considerable management judgment
is necessary to estimate the fair value of assets; accordingly, actual results
could vary significantly from estimates. Assets to be disposed of are carried
at the lower of their financial statement carrying amount or fair value less
costs to sell. For the year ended December 31, 2001, the Company recorded $9.6
million in impairment of certain non-revenue generating assets and a $2.4
million impairment of assets related to the restructure activities described
in note 3.
F-10
TIME WARNER TELECOM INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Revenue
The Company's revenue has been derived primarily from business telephony
services, including dedicated transport, local, switched, long distance, data,
and high-speed Internet access services. The Company's customers are
principally telecommunications-intensive business end users, long distance
carriers, Internet service providers ("ISPs"), wireless communications
companies, and governmental entities.
Revenue for dedicated transport, data, Internet, and the majority of
switched services exclusive of switched access is generally billed in advance
on a fixed rate basis and recognized over the period the services are
provided. Revenue for the majority of switched access and long distance is
generally billed on a transactional basis determined by customer usage with
some fixed rate elements. The transactional elements of switched services are
billed in arrears and estimates are used to recognize revenue in the period
earned. The fixed rate elements are billed in advance and recognized over the
period the services are provided.
Reciprocal compensation revenue is an element of switched services revenue
which represents compensation from local exchange carriers ("LECs") for local
exchange traffic originated on a LEC's facilities and terminated on the
Company's facilities. Reciprocal compensation represented 6%, 6%, and, 7% of
revenue for 2001, 2000, and 1999, excluding the effects of the recognition of
$37.0 million, $27.3 million, and $7.6 million, respectively, of non-recurring
reciprocal compensation. These non-recurring amounts primarily reflect the
resolution of disputes with other LECs. Reciprocal compensation is based on
contracts between the Company and other LECs. The Company recognizes
reciprocal compensation revenue as it is earned, except in those cases where
the revenue is under dispute or at risk. The payment of reciprocal
compensation under certain of the Company's interconnection agreements is, by
the terms of those agreements, subject to adjustment or repayment depending on
prospective federal or state generic rulings with respect to reciprocal
compensation for ISP traffic. The Company pays reciprocal compensation expense
to other LECs for local exchange traffic it terminates on the LEC's
facilities. These costs are recognized as incurred.
As of December 31, 2001 and 2000, the Company had deferred recognition of
$28.0 million and $41.0 million in reciprocal compensation revenue,
respectively, for payments received pending disputes and agreements subject to
future adjustments.
Switched access is the connection between a long distance carrier's point
of presence and an end user's premises provided through the switching
facilities of a LEC. Historically, the Federal Communications Commission
("FCC") has regulated the access rates imposed by the incumbent local exchange
carriers ("ILECs"), while the competitive local exchange carriers' ("CLECs")
access rates have been less regulated. However, the FCC released an order
effective in June 2001 that subjects CLECs' interstate switched access charges
to regulation. Effective with that order, the Company's rates were reduced and
will continue to decline over a three-year period to parity with the ILEC
rates competing in each area. In addition, when a CLEC enters a new market,
its access charges may be no higher than the ILEC's. This order does not
affect rates established by contracts between the Company and certain long
distance carriers. The Company and several other CLECs have filed petitions
with the FCC for reconsideration of the provisions of the order relating to
new markets and expects that there will be other legal challenges to the order
filed in federal court. There is no assurance that any legal challenge will be
successful or that a successful challenge will change the trend toward lower
access charges. Switched access revenue represented 7%, 11%, and 12% of
revenue for 2001, 2000, and 1999, respectively, excluding the effects of the
recognition of $37.0 million, $27.3 million, and $7.6 million of non-recurring
reciprocal compensation during 2001, 2000, and 1999, respectively. The Company
expects that switched access revenue will continue to decline as a percentage
of the Company's total revenue due to mandated or contracted rate reductions.
There is no assurance that the Company will be able to compensate for
reductions in switched access revenue resulting from the FCC order with
revenue from other sources.
F-11
TIME WARNER TELECOM INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Significant Customers
The Company has substantial business relationships with a few large
customers, including the major long distance carriers. The Company's top 10
customers accounted for 47%, 48%, and 48% of the Company's consolidated
revenue for 2001, 2000, and 1999, respectively. Excluding the impact of the
recognition of no-recurring reciprocal compensation noted above, the Company's
top 10 customers accounted for 44%, 45%, and 48% of the Company's consolidated
revenue for 2001, 2000, and 1999, respectively. WorldCom Inc. accounted for
12% and 11% of the Company's total revenue, or $88.4 million and $55.0
million, in 2001 and 2000, respectively, and AT&T accounted for more than 10%
of the Company's total revenue or $34.7 million, in 1999. However, a
substantial portion of this revenue results from traffic that is directed to
the Company by customers who have selected AT&T or WorldCom Inc. as their long
distance provider.
Segment Reporting
The Company operates in 44 service areas, and the Company's management
makes decisions on resource allocation and assesses performance based on total
revenue, EBITDA, and capital spending of these operating locations. Each of
the service areas offers the same services, has similar customers and
networks, are regulated by the same type of authorities, and are managed
directly by the Company's executives, allowing the 44 service areas to be
aggregated, resulting in one reportable line of business.
Earnings (Loss) Per Common Share and Potential Common Share
The Company computes earnings (loss) per common share in accordance with
the provisions of SFAS No. 128, Earnings Per Share ("SFAS 128"). SFAS 128
requires companies with complex capital structures to present basic and
diluted earnings per share ("EPS"). Basic EPS is measured as the income or
loss available to common stockholders divided by the weighted average
outstanding common shares for the period. Diluted EPS is similar to basic EPS
but presents the dilutive effect on a per share basis of potential common
shares (e.g., convertible securities, stock options, etc.) as if they had been
converted at the beginning of the periods presented. Potential common shares
that have an anti-dilutive effect (e.g., those that increase income per share
or decrease loss per share) are excluded from diluted EPS.
Basic earnings (loss) per share for all periods presented herein was
computed by dividing the net income (loss) by the weighted average shares
outstanding for the period.
The diluted loss per common share for the years ended December 31, 2001 and
1999 was computed by dividing the net loss attributable to common shares by
the weighted average outstanding common shares for the period. Potential
common shares were not included in the computation of weighted average shares
outstanding because their inclusion would be anti-dilutive. The diluted
earnings per share for the year ended December 31, 2000 was computed by
dividing the net income by the weighted average number of common shares and
dilutive potential common shares outstanding during the period.
Options to purchase 14,370,000, 473,000, and 8,174,000 shares of the
Company's Class A common stock outstanding at December 31, 2001, 2000, and
1999 were excluded from the computation of weighted average shares outstanding
because their inclusion would be anti-dilutive.
F-12
TIME WARNER TELECOM INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Set forth below is a reconciliation of the basic and diluted earnings
(loss) per share for each period:
Years Ended December 31,
-------------------------
2001 2000 1999
-------- ------- -------
(amounts in thousands,
except per share
amounts)
Net income (loss) for basic and diluted
earnings (loss) per share..................... $(81,167) 1,216 (89,265)
======== ======= =======
Weighted-average number of shares--basic....... 113,730 105,391 95,898
Dilutive effect of stock options............... -- 3,061 --
-------- ------- -------
Weighted-average number of shares--diluted..... 113,730 108,452 95,898
======== ======= =======
Earnings (loss) per share:
Basic........................................ $ (0.71) 0.01 (0.93)
======== ======= =======
Diluted...................................... $ (0.71) 0.01 (0.93)
======== ======= =======
Estimates
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities at the date of the financial statements and the reported amounts
of revenue and expenses during the reporting period. Actual results could
differ from those estimates.
Reclassifications
Certain prior year amounts have been reclassified for comparability with
the 2001 presentation.
Recent Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
Accounting for Derivative Instruments and Hedging Activities ("SFAS 133"), as
amended by SFAS 138, which was adopted by the Company on January 1, 2001. SFAS
133 requires that all derivatives be recorded on the balance sheet at fair
value. Changes in derivatives that are not hedges are adjusted to fair value
through income. Changes in derivatives that meet SFAS 133's hedge criteria are
either offset through income or recognized in other comprehensive income until
the hedged item is recognized in earnings. The adoption of SFAS 133 on January
1, 2001 did not have a material effect on the Company's financial condition,
results of operations, or cash flows because the Company does not own
derivative instruments.
In July 2001, the Financial Accounting Standards Board issued SFAS No. 141,
Business Combinations ("SFAS 141") and SFAS No. 142, Goodwill and Other
Intangible Assets ("SFAS 142"). SFAS 141 requires companies to reflect
intangible assets apart from goodwill and supercedes previous guidance related
to business combinations. SFAS 142 eliminates amortization of goodwill and
amortization of indefinite-lived intangible assets. However, SFAS 142 also
requires the Company to perform impairment tests at least annually on all
goodwill and indefinite-lived intangible assets. These statements are required
to be adopted by the Company on January 1, 2002 and for any acquisitions
entered into after July 1, 2001. The Company does not believe the adoption of
the statements will negatively impact its financial position, results of
operations, and cash flows. Goodwill amortization expense aggregated $2.8
million, $3.2 million, and $2.0 million in 2001, 2000, and 1999, respectively.
F-13
TIME WARNER TELECOM INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
In August 2001, the Financial Accounting Standards Board issued SFAS No.
144, Accounting for the Impairment or Disposal of Long-Lived Assets ("SFAS
144"). SFAS 144 addresses financial accounting and reporting for the
impairment or disposal of long-lived assets and supercedes SFAS No. 121,
Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets
to be Disposed Of, and the accounting and reporting provisions of Accounting
Principles Board Opinion No. 30, Reporting the Results of Operation for a
disposal of a segment of a business. SFAS 144 is required to be adopted by the
Company on January 1, 2002 and the Company does not believe the adoption of
the standard will have a significant impact on its financial position, results
of operations, and cash flows.
2. Acquisitions
On January 10, 2001, the Company completed the acquisition of substantially
all of the assets of GST out of bankruptcy for a contractual purchase price of
$690 million. The $690 million included payments to GST or third parties on
behalf of GST totaling approximately $662 million, the assumption of
approximately $21 million in obligations to complete certain fiber networks
and a liability to provide transitional services to GST of approximately $7
million. In addition to the $690 million contractual purchase price, the
Company paid approximately $6 million in transaction expenses and assumed
approximately $17 million in liabilities primarily related to capital leases.
As a result of this acquisition, the Company added 15 markets, approximately
4,210 route miles, and approximately 227,674 fiber miles in the western United
States. This transaction has been accounted for under the purchase method of
accounting, and the deficiency of the purchase price compared to the fair
market value of assets acquired has been allocated to the acquired fixed
assets.
The accounting for the GST asset acquisition is summarized as follows
(amounts in thousands):
Recorded value of fixed assets acquired............................ $683,784
Receivables, prepaids, and other assets............................ 28,271
Deposit paid in 2000............................................... (10,000)
Assumed liabilities................................................ (50,366)
--------
Cash paid for acquisition in 2001................................ $651,689
========
Since this acquisition is accounted for as a purchase, the results of
operations are consolidated with the Company's results of operations from the
acquisition date. Had this acquisition occurred on January 1, 2000, total
revenue, net loss, and basic and diluted loss per common share for 2000 would
have been approximately $601 million, $98 million, and $0.93, respectively.
The pro forma results do not include any anticipated cost savings or other
effects of the integration of the GST assets into the Company and are not
necessarily indicative of the results which would have occurred if the
acquisition had been in effect on the date indicated, or which may result in
the future.
During the second quarter of 1999, the Company acquired all of the
outstanding common stock of Internet Connect, Inc., an ISP, for consideration
consisting of $3.8 million of Class A limited liability interests in TWT LLC,
approximately $3.5 million in net cash, and the assumption of $1.9 million in
liabilities. At the time of the IPO, these Class A limited liability interests
were converted into 307,550 shares of Class A common stock of the Company that
were placed in escrow and are being released to the former Internet Connect,
Inc. shareholders over a period of three years, beginning in April 2000. The
transaction was accounted for under the purchase method of accounting and
generated $6.9 million in goodwill, which is being amortized on a straight-
line basis over a ten-year period. Amortization expense aggregated $690,000,
$690,000, and $462,000 for the years ended December 31, 2001, 2000, and 1999,
respectively.
F-14
TIME WARNER TELECOM INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
During the second quarter of 1999, the Company acquired all of the
outstanding common stock of MetroComm L.P. through the issuance of 2,190,308
shares of Class A common stock of the Company valued at $24.1 million, and the
assumption of $20.1 million in liabilities. Through the acquisition of
MetroComm L.P., the Company acquired the 50% interest of MetroComm L.P. not
already owned by the Company. After the acquisition, the Company's Columbus,
Ohio assets were transferred to MetroComm L.P. and all operations in Columbus,
Ohio are now reported under the new entity. The transaction was accounted for
under the purchase method of accounting and generated $18.8 million in
goodwill, which is being amortized on a straight-line basis over a ten-year
period. Amortization expense aggregated $1.9 million, $1.9 million, and $1.1
million for the years ended December 31, 2001, 2000, and 1999, respectively.
The accounting for the two 1999 acquisitions is summarized as follows
(amounts in thousands):
Recorded value of assets acquired................................... $32,003
Goodwill............................................................ 25,746
Elimination of investment in unconsolidated affiliate............... (5,278)
Assumed liabilities................................................. (22,042)
Common stock issued in acquisitions................................. (27,864)
-------
Cash paid for acquisitions........................................ $ 2,565
=======
Since both 1999 acquisitions were accounted for as purchases, the results
of operations of Internet Connect, Inc. and MetroComm L.P. have been
consolidated with the Company's results of operations from their respective
acquisition dates. Had both acquisitions occurred on January 1, 1999, revenue,
net loss, and basic and diluted loss per common share would not have been
materially different for 1999.
3. Restructure charge
In the fourth quarter of 2001, the Company recorded a restructure charge of
$6.8 million as a result of a decision to consolidate its network operations
centers by closing a facility in Vancouver, Washington and eliminating
approximately 200 positions. In addition, the Company consolidated its offices
in Houston into one facility. These decisions were made to create efficiencies
in the Company's sales, billing, customer care, and network surveillance and
maintenance processes and to reduce overhead by centralizing offices. The
Company estimates that the restructuring will save between $10 million and $14
million in operating costs per year without materially impacting its revenues.
The $6.8 million charge included the following:
. $2.7 million in severance-related costs. Most of the 200 positions were
eliminated during the fourth quarter of 2001 and the first quarter of
2002.
. A $2.4 million non-cash impairment charge to write-down the value of
facilities in Vancouver, Washington. This charge represents the
difference between the expected sales value of the facilities, which
include a building, improvements, land, and furniture and fixtures, and
their book value.
. $0.6 million in operating costs related to the Vancouver facility to be
sold. These costs represent the costs to operate and maintain the
facility from the time it is vacated through the estimated sale date of
December 31, 2002.
. $0.6 million in contractual lease expenses primarily related to the cost
to terminate a facility lease in Houston, Texas.
. $0.6 million in other costs related to the restructuring activities.
F-15
TIME WARNER TELECOM INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The components of the restructure charge and the amounts paid and accrued
as of December 31, 2001 are as follows:
Accrued at
Total Paid Non- December 31,
Charge in 2001 Cash 2001
------ ------- ----- ------------
(amounts in thousands)
Employee severance......................... $2,670 1,138 -- 1,532
Facilities impairment...................... 2,359 -- 2,359 --
Facility operating costs................... 601 68 -- 533
Contractual lease commitments.............. 628 -- -- 628
Other restructure expenses................. 580 142 -- 438
------ ----- ----- -----
$6,838 1,348 2,359 3,131
====== ===== ===== =====
4. Marketable debt securities
The Company's marketable debt securities portfolio includes shares of money
market mutual funds and corporate and municipal debt securities. All of the
Company's marketable debt securities are categorized as "held-to-maturity" and
carried at amortized cost.
Marketable debt securities at December 31, 2001 and 2000 were as follows:
2001 2000
-------- ------
(amounts in
thousands)
Cash equivalents:
Shares of money market mutual funds....................... $ 93,323 204
Corporate and municipal debt securities................... 268,220 68,652
-------- ------
Total cash equivalents.................................. 361,543 68,856
Marketable debt securities--corporate and municipal debt.... 18,454 3,496
-------- ------
Total marketable debt securities........................ $379,997 72,352
======== ======
The estimated fair value of the marketable debt securities is not
materially different from the amortized cost.
5. Long-Term Debt and Capital Lease Obligations
Long-term debt and capital lease obligations are summarized as follows:
December 31,
------------------
2001 2000
---------- -------
(amounts in
thousands)
9 3/4% Senior Notes....................................... $ 400,000 400,000
10 1/8% Senior Notes...................................... 400,000 --
Credit Facility........................................... 250,000 179,000
Capital lease obligations................................. 13,368 6,107
---------- -------
$1,063,368 585,107
========== =======
The $400 million principal amount 9 3/4% Senior Notes due July 2008 (the "9
3/4% Senior Notes") are unsecured, unsubordinated obligations of the Company.
Interest on the 9 3/4% Senior Notes is payable semi-annually on January 15 and
July 15, and began on January 15, 1999. Interest expense, including
amortization of
F-16
TIME WARNER TELECOM INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
deferred debt issue costs, relating to the 9 3/4% Senior Notes totaled
approximately $40.2 million, $40.2 million, and $40.3 million for 2001, 2000,
and 1999, respectively. At December 31, 2001, the fair market value of the
$400 million of 9 3/4% Senior Notes was $314 million, based on market prices.
The $400 million principal amount 10 1/8% Senior Notes are unsecured,
unsubordinated obligations of the Company. Interest on the 10 1/8% Senior
Notes is payable semiannually on February 1 and August 1, and began on August
1, 2001. Interest expense, including amortization of deferred debt issue
costs, relating to the 10 1/8% Senior Notes totaled approximately $39.0
million for 2001. At December 31, 2001, the fair market value of the $400
million of 10 1/8% Senior Notes was $318 million, based on market prices.
The 9 3/4% Senior Notes and the 10 1/8% Senior Notes are governed by
indentures that contain certain restrictive covenants. These restrictions
affect, and in many respects significantly limit or prohibit, among other
things, the ability of the Company to incur indebtedness, make prepayments of
certain indebtedness, pay dividends, make investments, engage in transactions
with shareholders and affiliates, issue capital stock of subsidiaries, create
liens, sell assets, and engage in mergers and consolidations.
On April 10, 2000, the Company executed a $475 million Senior Secured
Revolving Credit Facility (the "Revolver"). In connection with the acquisition
of GST assets and the Company's capital expenditure plans, the Company
replaced the Revolver with an amended and restated senior secured credit
facility (the "Credit Facility") providing for an aggregate of $1 billion in
borrowings, comprised of $525 million of senior secured term loan facilities
and a $475 million senior secured revolving credit facility. The Credit
Facility has a final maturity of March 31, 2008. The Company also obtained
$700 million in senior unsecured bridge financing that it used to initially
finance the GST asset acquisition. The borrowings under the senior unsecured
bridge loan facility were made and repaid in full in January 2001, with the
net proceeds from the Offering and a portion of the net proceeds from the sale
of the Old Notes. In connection with the repayment of the senior unsecured
bridge loan facility, the Company recorded $5.8 million of deferred financing
costs as a non-recurring expense, as well as $3.5 million in interest expense
for 2001. In December 2000, the Company was required to draw and hold in
escrow $179 million of the Credit Facility until the closing of the GST asset
acquisition at which time the draw increased to $250 million. Principal
payments on the outstanding balance of $250 million will be $2.5 million per
year from 2003 through 2007 with a final payment of $237.5 million due in
March 2008. Interest expense on the $250 million drawn under the Credit
Facility is computed utilizing a specific Eurodollar rate plus 4.0%, which
totaled 6.1% as of December 31, 2001. Interest is payable at least quarterly.
Interest expense relating to the $250 million draw, including amortization of
deferred debt issue costs, was $22.2 million for 2001.
At December 31, 2001, the undrawn available commitment under the Credit
Facility was $750 million, consisting of $275 million in senior secured term
loan facilities and the $475 million senior secured revolving facility. The
undrawn $275 million of senior secured term loan facilities must be drawn by
January 10, 2003, or it will expire. Amounts available under the $475 million
revolving facility decrease to $451.3 million on December 31, 2004, $380.0
million on December 31, 2005, and $237.5 million on December 31, 2006 with a
final maturity of December 31, 2007. The Company is required to pay commitment
fees on a quarterly basis ranging from 0.500% to 1.000% per annum on the
undrawn available commitment of the Credit Facility. Commitment fee expense
was $9.1 million for 2001 and has been classified as a component of interest
expense in the accompanying consolidated statements of operations.
Borrowings under the Credit Facility are secured by substantially all of
the assets of the Company, including the assets acquired from GST, except for
certain assets with respect to which the grant of a security interest is
prohibited by governing agreements. The Credit Facility requires the Company
to prepay outstanding loans when its cash flow exceeds certain levels and with
the proceeds received from a number of specified events or
F-17
TIME WARNER TELECOM INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
transactions, including certain asset sales and insurance recoveries for
assets not replaced. In addition, obligations under the Credit Facility are
subject to various covenants that limit the Company's ability to:
. borrow and incur liens on its property;
. pay dividends or make other distributions; and
. make capital expenditures.
The Credit Facility also contains financial covenants, including a leverage
ratio, an interest coverage ratio, and a debt service coverage ratio, as well
as cross default provisions. Under the cross default provisions, the Company
is deemed to be in default under the Credit Facility if the Company has
defaulted under any of the other material outstanding obligations, including
the 9 3/4% Senior Notes or the 10 1/8% Senior Notes.
6. Related Party Transactions
In the normal course of business, the Company engages in various
transactions with Time Warner Cable, generally on negotiated terms among the
affected units that, in management's opinion, result in reasonable
allocations.
The Company benefits from its strategic relationship with Time Warner Cable
both through access to local right-of-way and construction cost-sharing.
Certain of the Company's networks have been constructed through the use of
fiber capacity licensed from Time Warner Cable. Under this licensing
arrangement, the Company paid Time Warner Cable $1.1 million, $2.2 million,
and $16.8 million for 2001, 2000, and 1999, respectively. These costs have
been capitalized by the Company and the related amortization expense totaled
$13.4 million, $11.3 million, and $10.8 million for 2001, 2000, and 1999,
respectively. In addition, under this licensing arrangement, the Company
reimburses Time Warner Cable for facility maintenance, conduit rental, and
pole rental costs, which totaled $2.8 million, $2.7 million, and $2.5 million
for 2001, 2000, and 1999, respectively.
The Company's operations, which in certain cases are co-located with Time
Warner Cable's divisions, are allocated a charge for various services provided
by the Time Warner Cable divisions. These costs are based on contracts with
Time Warner Cable and aggregated approximately $1.7 million in 2001 and $1.6
million in each of 2000 and 1999.
During the period from July 1, 1997 through July 14, 1998, all of the
Company's financing requirements were funded with subordinated loans from Time
Warner Inc., Time Warner Entertainment Company, L.P., and Time Warner
Entertainment-Advance/Newhouse Partnership (the "Former Parent Companies").
These loans remained outstanding, accruing interest, through May 14, 1999. The
loans bore interest (payable in kind) at Chase Manhattan Bank's prime rate,
which was 7.75% from January 1, 1999 through the payoff of the loan in May
1999. Interest expense relating to these loans totaled approximately $5.1
million for 1999. On May 14, 1999, approximately $180 million of the proceeds
from the IPO were used to repay the subordinated loans payable to the Former
Parent Companies in full, including accrued interest.
AOL Time Warner and related entities purchase telecommunications services
from the Company. Revenue from these services aggregated $25.5 million, $11.2
million, and $3.6 million for 2001, 2000, and 1999, respectively.
F-18
TIME WARNER TELECOM INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
7. Income Taxes
On May 10, 1999, in conjunction with the Reconstitution, a one-time charge
to earnings of $39.4 million was recorded to recognize the net deferred tax
liability associated with the change from a limited liability company to a
corporation, as all of the Company's tax operating losses prior to May 10,
1999 were absorbed by the holders of Class B common stock. The income tax
expense (benefit) for 2001, 2000, and 1999 shown below includes the effect of
the Reconstitution and the tax impact of operations from the date of the
Reconstitution through December 31, 2001.
Income tax expense (benefit) for the years ended December 31, 2001, 2000,
and 1999 is as follows:
2001 2000 1999
--------- ----- ------
(amounts in thousands)
Current:
Federal............................................ $ -- -- --
State.............................................. 1,058 1,359 --
--------- ----- ------
1,058 1,359 --
--------- ----- ------
Deferred:
Federal............................................ (41,509) 2,579 23,873
State.............................................. (7,805) 759 5,931
--------- ----- ------
(49,314) 3,338 29,804
--------- ----- ------
$(48,256) 4,697 29,804
========= ===== ======
Total income tax expense (benefit) differed from the amounts computed by
applying the federal statutory income tax rate of 35% to earnings (loss)
before income taxes as a result of the following items for the years ended
December 31, 2001, 2000, and 1999:
2001 2000 1999
----- ---- -----
Federal statutory income tax expense (benefit).......... (35.0)% 35.0% (35.0)%
State income tax expense (benefit), net of federal
income tax expense (benefit)........................... (3.4) 23.2 (2.1)
Effect of net operating losses incurred prior to the
Reconstitution......................................... -- -- 18.5
Effect of the initial deferred tax liability recorded at
the time of the Reconstitution......................... -- -- 66.4
Goodwill amortization................................... 0.8 18.2 0.9
Other................................................... 0.3 3.0 1.4
----- ---- -----
Income tax expense (benefit)........................ (37.3)% 79.4% 50.1%
===== ==== =====
F-19
TIME WARNER TELECOM INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The tax effects of temporary differences that give rise to significant
components of the Company's deferred tax assets and liabilities at December
31, 2001 and 2000 are as follows:
2001 2000
-------- -------
(amounts in
thousands)
Current deferred tax assets:
Accrued liabilities.................................... $ 16,878 9,155
Allowance for doubtful accounts........................ 10,607 8,730
Deferred revenue....................................... 7,664 16,486
Other.................................................. 421 47
-------- -------
Current deferred tax assets.......................... 35,570 34,418
======== =======
Non-current deferred tax assets (liabilities):
Depreciation and amortization.......................... (89,508) (69,615)
Unrealized gains....................................... 132 (4,364)
Net operating loss carryforwards....................... 113,006 27,816
-------- -------
Non-current deferred tax assets (liabilities), net... 23,630 (46,163)
-------- -------
Net deferred tax assets (liabilities).................. $ 59,200 (11,745)
======== =======
At December 31, 2001, the Company had net operating loss carryforwards, for
federal income tax purposes, of approximately $293.9 million. These net
operating loss carryforwards, if not utilized to reduce taxable income in
future periods, will expire in various amounts beginning in 2019 and ending in
2021.
The Company has analyzed and will continue to analyze the sources and
expected reversal periods of its deferred tax assets. The Company has also
identified and analyzed tax planning strategies that can be employed to
utilize net operating loss carryforwards. The Company believes that the tax
benefits attributable to deductible temporary differences will be realized by
recognition of future taxable amounts. The Company would employ tax planning
strategies to avoid losing the benefit of any significant expiring net
operating loss carryforward. The Company has determined that it is more likely
than not that the net deferred tax asset will be realized and therefore, no
valuation allowance has been recorded.
8. Option Plans--Common Stock and Stock Options
Time Warner Telecom 1998 Employee Stock Option Plan
The Company maintains an employee stock option plan that reserved 9,027,000
shares of Class A common stock to be issued to officers and eligible employees
under terms and conditions to be set by the Company's Board of Directors.
Generally, the options vest over periods of up to four years and expire ten
years from the date of issuance. These options have generally been granted to
employees of the Company at an estimated fair value at the date of grant, and
accordingly, no compensation cost has been recognized by the Company relating
to this option plan.
During 1999, the Company granted options to purchase 100,000 shares outside
of the option plan. Deferred compensation expense of $2.1 million was recorded
and is being amortized on a straight-line basis over the four-year vesting
period. In 2001, 2000, and 1999, stock compensation expense of approximately
$525,000, $525,000, and $88,000, respectively, was recorded for such options
and has been reported as a component of selling, general, and administrative
expenses in the accompanying consolidated statements of operations.
F-20
TIME WARNER TELECOM INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Time Warner Telecom 2000 Employee Stock Plan
The Company maintains an employee stock plan that reserved 12,000,000
shares of Class A common stock to be issued pursuant to stock options and
stock awards granted to officers, directors, and eligible employees under
terms and conditions to be set by the Company's Board of Directors. Generally,
the options vest over periods of up to four years and expire ten years from
the date of issuance. These options have generally been granted to employees
of the Company at an estimated fair value at the date of grant, and
accordingly, no compensation cost has been recognized by the Company relating
to these options.
During 2001, the Company granted restricted stock awards aggregating
275,000 shares to certain officers of the Company. Deferred compensation of
$4.0 million was recorded and is being amortized on a straight-line basis over
the four-year vesting period. In 2001, stock compensation expense of
approximately $169,000 was recorded for such stock awards and is reported as a
component of selling, general, and administrative expenses in the accompanying
consolidated statements of operations.
Valuation of the Time Warner Telecom 1998 Stock Option Plan and the Time
Warner Telecom 2000 Employee Stock Plan
The Company has elected to follow Accounting Principles Board Opinion No.
25 ("APB 25"), Accounting for Stock Issued to Employees and related
interpretations in accounting for its employee stock options. Under APB 25,
because the exercise price of the Company's employee stock options is
generally equal to the market price of the underlying stock on the date of the
grant, no compensation expense is recognized. SFAS No. 123, Accounting and
Disclosure of Stock-Based Compensation ("SFAS 123"), establishes an
alternative method of expense recognition for stock-based compensation awards
to employees based on fair values. The Company elected not to adopt SFAS 123
for expense recognition purposes.
Pro forma information regarding net income and earnings per share is
required by SFAS 123, and has been determined as if the Company had accounted
for its employee stock options under the fair value method of SFAS 123. The
fair value for these options was estimated at the date of grant using a Black-
Scholes option pricing model with the following weighted-average assumptions:
risk-free interest rate of 4.6%, 6.5%, and 6.5% in 2001, 2000, and 1999,
respectively; dividend yield of 0.0% during each period; volatility factor of
the expected market price of the Company's common stock of 0.93, 0.80, and
0.74 for 2001, 2000, and 1999, respectively; and a weighted-average expected
life of the option of five years during each period.
The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options which have no vesting restrictions
and are fully transferable. In addition, option valuation models require the
input of highly subjective assumptions including expected stock price
characteristics significantly different from those of traded options. Because
changes in the subjective input assumptions can materially affect the fair
value estimate, in management's opinion, the existing models do not
necessarily provide a reliable single measure of the fair value of its
employee stock options.
The weighted-average fair value of options granted during 2001, 2000, and
1999 was $20.41, $39.83, and $19.98, respectively. For purposes of pro forma
disclosures, the estimated fair value of the options is amortized to expense
over the options' vesting period. The Company's pro forma net loss and pro
forma net loss per share as if the Company had used the fair value accounting
provisions of SFAS 123 would be a loss of $155.9 million, $42.3 million, and
$103.1 million, and a loss per share of $1.37, $0.40, and $1.07 for the years
ended December 31, 2001, 2000, and 1999, respectively.
F-21
TIME WARNER TELECOM INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The table below summarizes the Company's stock option activity and related
information for the years ended December 31, 2001, 2000, and 1999.
2001 2000 1999
-------------------- -------------------- -------------------
Weighted Weighted Weighted
Avg Avg Avg
Exercise Exercise Exercise
Options Price Options Price Options Price
---------- -------- ---------- -------- --------- --------
Options outstanding at
beginning of year...... 10,445,404 $34.03 8,174,057 $18.44 5,810,750 $12.00
Granted................. 5,670,525 27.77 3,822,111 60.26 2,950,750 29.90
Exercised............... (946,723) 12.79 (1,079,719) 12.51 (309,849) 12.00
Forfeited............... (799,420) 48.06 (471,045) 26.19 (277,594) 12.63
Options outstanding at
end of year............ 14,369,786 32.16 10,445,404 34.03 8,174,057 18.44
Exercisable at end of
year................... 4,409,544 27.38 2,304,582 12.66 1,784,036 12.00
Exercise prices for options outstanding and exercisable as of December 31,
2001, are as follows:
Options Outstanding Options Exercisable
-------------------------------------- ------------------------
Number of Weighted Number of
Outstanding Avg Weighted Exercisable Weighted
Range of as of Remaining Avg as of Avg
Exercise December 31, Contractual Exercise December 31, Exercise
Prices 2001 Life Price 2001 Price
-------- ------------ ----------- -------- ------------ --------
$ 5.98-12.00 4,115,036 7.34 $10.94 2,563,416 $11.89
12.17-14.72 2,545,435 9.75 14.67 59,330 14.00
15.36-34.50 2,889,324 8.25 31.72 648,507 32.70
35.75-61.00 3,457,730 8.69 56.95 971,415 58.21
61.25-87.00 1,362,261 8.86 66.91 166,876 69.96
---------- ---------
14,369,786 4,409,544
========== =========
9. Commitments and Contingencies
The Company leases office space and furniture, switching facilities, and
fiber optic use rights. Certain of these leases contain renewal clauses.
At December 31, 2001, commitments under capital and non-cancelable
operating leases and maintenance agreements with terms in excess of one year
were as follows:
Fixed
Capital Operating Maintenance
Leases Leases Obligations
------- --------- -----------
(amounts in thousands)
Year ended December 31:
2002............................................. $ 6,031 27,078 4,101
2003............................................. 4,009 25,389 4,101
2004............................................. 3,192 22,706 4,101
2005............................................. 2,552 19,390 3,005
2006............................................. 2,301 16,491 3,005
Thereafter....................................... 11,222 89,817 53,041
------- ------- ------
Total minimum lease payments................... $29,307 200,871 71,354
======= ======
Less amount representing interest............ 11,887
-------
Present value of obligations under capital... 17,420
Less current portion of obligations under
capital leases.............................. 4,052
-------
Obligations under capital leases, excluding
current portion............................. $13,368
=======
F-22
TIME WARNER TELECOM INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
As of December 31, 2001 and 2000, assets under capital lease obligations
totaled $22.3 million and $10.5 million, respectively, with related
accumulated depreciation of $6.3 million and $1.9 million, respectively.
Depreciation expense related to assets under capital lease obligations totaled
$4.4 million, $1.8 million, and $2.4 million in 2001, 2000, and 1999,
respectively. The obligations under capital leases have been discounted at an
imputed interest rate of 11.54%. Rental expense under operating leases
aggregated $31.4 million, $17.5 million, and $9.4 million for 2001, 2000, and
1999, respectively.
Pending legal proceedings are substantially limited to litigation
incidental to the business of the Company. In the opinion of management, the
ultimate resolution of these matters will not have a material adverse effect
on the Company's financial statements.
10. Employee Benefit Plans
Effective January 1, 1999, the Company adopted the "TWTC 401(k) by Time
Warner Telecom" qualified retirement plan (the "401(k) Plan"). Employees who
meet certain eligibility requirements may contribute up to 15% of their
eligible compensation, subject to statutory limitations, to a trust for
investment in several diversified investment choices, as directed by the
employee. The Company made a matching contribution of 100% of each employee's
contribution up to a maximum of 5% of the employee's eligible compensation.
Contributions to the 401(k) Plan aggregated $7.4 million, $4.4 million, and
$3.3 million for 2001, 2000, and 1999, respectively.
Effective January 1, 2000, the Company adopted the "Time Warner Telecom
2000 Qualified Stock Purchase Plan" (the "Stock Purchase Plan"). Employees who
meet certain eligibility requirements may elect to designate up to 15% of
their eligible compensation, up to an annual limit of $25,000, to purchase
shares of the Company's Class A common stock at a 15% discount to fair market
value. Stock purchases occur twice a year on January 1 and July 1, with the
price per share equaling the lower of 85% of the market price at the beginning
or end of the offering period. The Company is authorized to issue a total of
750,000 shares of the Company's Class A common stock to participants in the
Stock Purchase Plan. For the year ended December 31, 2001 and 2000, the
Company issued 100,085 and 90,937 shares of Class A common stock under the
Stock Purchase Plan for net proceeds of $2.0 million and $4.0 million,
respectively.
F-23
TIME WARNER TELECOM INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
11. Quarterly Results of Operations (Unaudited)
The following summarizes the Company's unaudited quarterly results of
operations for 2001 and 2000:
Three Months Ended
------------------------------------------
March 31 June 30 September 30 December 31
-------- ------- ------------ -----------
(amounts in thousands, except per share
amounts)
Year Ended December 31, 2001
Total revenue(1).................. $173,127 217,897 172,725 173,958
Operating income (loss)........... (18,823) 28,651 (14,969) (24,941)
Net income (loss)................. (28,707) 4,385 (24,323) (32,522)
Basic and diluted income (loss)
per common share................. (0.26) 0.04 (0.21) (0.28)
Year Ended December 31, 2000
Total revenue(1).................. 100,138 131,773 121,156 134,267
Operating income.................. 1,594 24,783 4,388 5,557
Net income (loss)................. (2,860) 9,767 (2,325) (3,366)
Basic and diluted income (loss)
per common share................. $ (0.03) 0.09 (0.02) (0.03)
- --------
(1) Total revenue for the quarters ended June 30, 2001, March 31, 2000, and
June 30, 2000 include the recognition of non-recurring settlements of
reciprocal compensation of $37.0 million, $3.9 million, and $23.4 million,
respectively.
The total net income (loss) per share for the 2001 and 2000 quarters do not
equal net income (loss) per share for the respective years as the per share
amounts for each quarter and for each year are computed based on their
respective discrete periods.
F-24
TIME WARNER TELECOM INC.
SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS
Years Ended December 31, 2001, 2000, and 1999
Balance at Additions/Charges Balance
Beginning to Costs and at End
Of Period Expenses Deductions of Period
---------- ----------------- ---------- ---------
(amounts in thousands)
For the Year ended December
31, 2001:
Allowance for doubtful
accounts receivable....... $17,610 26,744 (14,576) 29,778
======= ====== ======= ======
For the Year ended December
31, 2000:
Allowance for doubtful
accounts receivable....... 7,857 15,974 (6,221) 17,610
======= ====== ======= ======
For the Year ended December
31, 1999:
Allowance for doubtful
accounts receivable....... 2,692 6,735 (1,570) 7,857
======= ====== ======= ======
F-25